Chapter

Article IV Consultations

Author(s):
International Monetary Fund
Published Date:
September 1996
Share
  • ShareShare
Show Summary Details

Under Article IV of the Articles of Agreement, the Fund holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepare a report, which forms the basis for discussion by the Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of the Directors, and this summary is transmitted to the country’s authorities. Table 4 lists the 143 Article IV consultations concluded by the Fund in 1995/96.

Table 4ARTICLE IV CONSULTATIONS CONCLUDED IN FINANCIAL YEAR 1996
AlbaniaMay 26, 1995GrenadaMay 12, 1995PanamaMay 12, 1995
AlgeriaMay 22, 1995GuatemalaMay 22, 1995Papua New GuineaJuly 14, 1995
AngolaOct. 18, 1995GuineaDec. 20, 1995ParaguayJuly 12, 1995
Antigua and BarbudaMay 1, 1995Guinea-BissauOct. 18, 1995PeruDec. 1, 1995
ArgentinaSept. 27, 1995GuyanaJune 16, 1995PhilippinesSept. 29, 1995
ArmeniaSept. 29, 1995Hong Kong2Mar. 8, 1996PolandJan. 17, 1996
Aruba1July 28, 1995IcelandMay 3, 1995PortugalOct. 20, 1995
AustraliaMar. 22, 1996IcelandJan. 19, 1996RomaniaDec. 21, 1995
AustriaMay 31, 1995IndiaJuly 10, 1995RussiaSept. 14, 1995
AzerbaijanNov. 17, 1995IndonesiaJuly 24, 1995RwandaSept. 18, 1995
Bahamas, TheJuly 31, 1995Iran, I. R. ofOct. 2, 1995São Tomé and Príncipe
BahrainFeb. 26, 1996IrelandJune 30, 1995June 7, 1995
BelarusSept. 12, 1995IsraelSept. 15, 1995Saudi ArabiaOct. 2, 1995
BelgiumFeb. 21, 1996ItalyMar. 15, 1996SenegalJune 9, 1995
BelizeApr. 26, 1996JapanJuly 21, 1995SeychellesApr. 17, 1996
BeninMay 22, 1995JordanSept. 6, 1995Sierra LeoneDec. 18, 1995
BhutanOct. 25, 1995KazakstanJan. 5, 1996SingaporeOct. 27, 1995
BoliviaMar. 25, 1996KenyaNov. 10, 1995Slovak RepublicSept. 1, 1995
BotswanaFeb. 12, 1996KiribatiNov. 15, 1995SloveniaSept. 1, 1995
BrazilDec. 15, 1995KoreaOct. 23, 1995Sri LankaMay 17, 1995
BulgariaDec. 21, 1995KuwaitAug. 28, 1995St. Kitts and NevisMay 19, 1995
Burkina FasoDec. 22, 1995
LatviaOct. 20, 1995St. VincentOct. 20, 1995
BurundiApr. 1, 1996
LesothoJuly 31, 1995SudanFeb. 13, 1996
Central African RepublicJune 26, 1995LithuaniaJuly 14, 1995SurinameMar. 13, 1996
LuxembourgApr. 26, 1996SwazilandDec. 1, 1995
CambodiaSept. 15, 1995
SwitzerlandFeb. 26, 1996
Macedonia, F.Y.R.May 5, 1995
CanadaMay 3, 1995
CanadaApr. 1, 1996MadagascarJune 9, 1995Syrian Arab Rep.Mar. 6, 1996
TanzaniaNov. 27, 1995
ChileSept. 8, 1995MalawiMay 10, 1995
ThailandJune 23, 1995
ChinaApr. 1, 1996MalaysiaOct. 2, 1995
ColombiaJan. 19, 1996MaldivesJune 26, 1995TogoDec. 20, 1995
MaliOct. 23, 1995TongaJune 16, 1995
Côte d’IvoireDec. 11, 1995Trinidad and TobagoApr. 26, 1996
CroatiaNov. 1, 1995Marshall IslandsJuly 27, 1995
MauritaniaApr. 17, 1996TunisiaFeb. 23, 1996
CyprusJan. 24, 1996
MauritiusNov. 20, 1995TurkmenistanFeb. 23, 1996
Czech RepublicJuly 28, 1995
DjiboutiApr. 15, 1996MexicoJune 30, 1995United Arab EmiratesJune 14, 1995
UkraineJan. 19, 1996
DominicaJune 16, 1995MicronesiaJuly 27, 1995
Oct. 30, 1995
Dominican RepublicJune 16, 1995MoldovaJune 21, 1995United Kingdom
Feb. 14, 1996United StatesAug. 4, 1995
EcuadorAug. 3, 1995Mongolia
Oct. 23, 1995UruguayJune 23, 1995
EagyptSept. 22, 1995Morocco
MozambiqueJune 9, 1995VietnamAug. 3, 1995
El SalvadorApr. 5, 1996
Western SamoaNov. 15, 1995
Equatorial GuineaOct. 25, 1995MyanmarOct. 20, 1995
FijiNov. 15, 1995NamibiaJuly 31, 1995Yemen, Republic ofMay 10, 1995
FinlandSept. 1, 1995NepalMay 24, 1995ZaïreMar. 1, 1996
FranceOct. 25, 1995NetherlandsMay 1, 1995ZimbabweFeb. 28, 1996
GabonNov. 8, 1995New ZealandNov. 20, 1995
Gambia, TheOct. 18, 1995NicaraguaJuly 10, 1995
GeorgiaSept. 29, 1995NigeriaNov. 1, 1995
GermanyAug. 30, 1995NorwayFeb. 7, 1996
GhanaJune 30, 1995OmanOct. 18, 1995
GreeceAug. 4, 1995PakistanDec. 13, 1995

Consultation discussions with Aruba are held in the context of the consultation with the Kingdom of the Netherlands.

Consultation discussions with Hong Kong are held in the context of the consultation with the United Kingdom.

Consultation discussions with Aruba are held in the context of the consultation with the Kingdom of the Netherlands.

Consultation discussions with Hong Kong are held in the context of the consultation with the United Kingdom.

In this section, the main features of the Board discussions on Article IV consultations with a number of countries are described. In addition, overviews summarizing policy trends in three groups of countries—the smaller industrial countries, developing countries, and countries in transition—are presented. The individual countries selected have been chosen because of their importance in the global or regional economy, with some smaller countries included on a rotating basis. For each country, a summary of the conclusion of the Board discussion is featured, with a brief description of salient macroeconomic and structural developments and a table of data available to the Board at the time of the consultation. Except in a few cases, subsequent revisions to the data have not been taken into account.

Industrial Countries

United States

Directors met in August 1995 to discuss the Fund’s Article IV consultation with the United States. The U.S. economic expansion that started in the second quarter of 1991 gained momentum during 1994 before decelerating in the first quarter of 1995, partly because of the tightening of monetary policy that began in early 1994. After rising at an average annual rate of 3.1 percent in 1993, real GDP increased by 4.1 percent in 1994 as domestic demand continued to drive growth while real net exports declined (see Table 5).

Table 5UNITED STATES: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in August 1995; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP2.33.14.12.8
Unemployment rate (in percent of labor force)27.46.86.15.7
Consumer price index3.03.02.63.0
External economy
Exports, f.o.b. (in billions of U.S. dollars)440.4456.8502.5552.23
Imports, c.i.f. (in billions of U.S. dollars)536.5589.4668.6732.43
Current account balance
(in percent of GDP)–1.1–1.6–2.2–2.5
Direct investment (in billions of U.S. dollars)–31.1–31.50.1–34.53
Securities, net (in billions of U.S. dollars)21.6–37.942.6158.23
Capital (official and private, in billions of U.S. dollars)85.063.9165.584.5
Real effective exchange rate–1.94.00.8
Gross international reserves
(in billions of SDRs)51.953.450.9
Financial variables
General government balance4–4.3–3.4–2.0–1.9
Federal5–4.8–4.1–3.1–2.5
Personal saving (in percent of GDP)4.13.03.0
Gross private investment
(in percent of GDP)13.113.915.3
Growth rate of M262.11.31.9
Three-month treasury bill interest rate 23.43.04.25.8
Ten-year government bond interest rate27.05.97.16.6

Projected.

Yearly average.

First quarter 1995 data on an annual basis.

On a national accounts basis and in percent of GDP.

On a unified budget, fiscal year basis and in percent of GDP.

Year over year, in percent.

Projected.

Yearly average.

First quarter 1995 data on an annual basis.

On a national accounts basis and in percent of GDP.

On a unified budget, fiscal year basis and in percent of GDP.

Year over year, in percent.

By the second quarter of 1995 the capacity utilization rate in manufacturing, particularly in the durables sector, was well above long-term average levels. The unemployment rate fell by about 1 percentage point from the first quarter of 1994 to the first quarter of 1995, when it stood at 5.5 percent. It subsequently rose to 5.7 percent in the second quarter.

Inflation was relatively steady during 1994, but some evidence of a temporary pickup in underlying inflation (excluding the effects of food and energy prices) emerged early in 1995. The federal funds rate, which had remained at 3 percent since September 1992, began to rise in February 1994 and reached 6 percent in February 1995. In July 1995 the Federal Reserve moved to cut the federal funds rate by 25 basis points.

The external current account deficit rose sharply in 1993 and 1994. The merchandise trade deficit widened further as the cyclical position of the United States improved relative to that of its trading partners. The current account deficit continued to grow during the first quarter of 1995, mainly because of a swing to deficit in the U.S. trade account with Mexico and a pronounced rise in merchandise imports.

In their discussion, Directors noted that in many respects the economic situation of the United States was very favorable, largely owing to the adoption of good policies; in particular, skillful management of monetary policy had helped to maintain unemployment and inflation at relatively low levels. The authorities’ success in achieving a substantial reduction in the structural budget deficit of the Federal Government had also been an important factor.

Directors observed that measures still were needed to strengthen national saving and reduce the federal debt as a share of GDP, as well as to further reduce inflation. Tangible progress in these areas would help to ensure that national saving would be sufficient to support satisfactory rates of investment and growth without an excessive reliance on foreign borrowing, and it would also reduce the risk of disruptions in world financial markets. Further progress in this area would appear appropriate from both domestic and international perspectives. They welcomed the authorities’ commitment to a balanced federal budget, which they considered an important signal. Some Directors observed that a more ambitious target would be preferable, in view of the need to bolster national saving and avoid placing an undue tax burden on future generations, although the practical difficulties in achieving a more ambitious target were recognized.

Directors expressed concern that the budget plans presented by the Administration and the Congress would involve front-loading of tax cuts and back-loading of expenditure cuts, which would delay much of the deficit reduction until the end of a seven- or ten year period. In addition, the budget-reduction plans relied heavily on the assumption that interest rates would drop substantially in response to deficit reduction. Such an outcome was possible, but could not be taken for granted. Moreover, the likelihood of a substantial drop in interest rates would be increased by a front-loaded program that bolstered the credibility of the adjustment effort and reduced its vulnerability to shifts in the economic and political environment. In this context, Directors felt it would be desirable to defer the introduction of any tax cuts until visible progress had been made toward balancing the budget.

Directors commended the Federal Reserve for its conduct of monetary policy during the 12-month period prior to the discussion, and, in particular, for having tightened monetary conditions in 1994 ahead of an actual increase in price pressures. These steps had improved the prospects for sustaining a noninflationary economic expansion and had greatly enhanced the credibility of the Federal Reserve’s commitment to price stability. Most Directors thought that the adoption of an explicit inflation target would not necessarily help in further enhancing such credibility. Moreover, Directors agreed that economic policies should not be aimed at specific targets for the dollar’s exchange rate.

While commending the U.S. authorities for their strong support of multilateral and regional trade liberalization, Directors regretted that frequent recourse by the United States to unilateral trade actions risked undermining these cooperative efforts. They encouraged the authorities to make more active use of existing multilateral procedures, and hoped that any future trade disputes could be resolved without threats of trade sanctions.

Directors noted with disappointment the decline in U.S. contributions to official development assistance as a share of GDP, but noted that such a decline was not a policy of the authorities.

Since the date of the consultation, the pace of economic activity appeared to strengthen. Sluggish performance of the economy in the second half of 1995 prompted the Federal Reserve to act to lower short-term interest rates to 5¼ percent from 5¾ percent in two steps in December 1995 and January 1996. Real GDP growth picked up to 2¾ percent (annual rate) in the first quarter of 1996, despite the adverse effects of severe winter weather and labor unrest. With strong employment growth, the unemployment rate fell to 5.4 percent in April. Although there has been upward pressure on energy and food prices, the underlying trend in price inflation has, for the most part, remained well contained, with core prices up at a 3 percent annual rate in the first third of the year, roughly the same pace as during 1995. Longer-term rates rose sharply in early 1996 owing in large part to a strengthening of economic activity, a renewed focus on energy and food price movements, and reduced prospects for enactment of a balanced budget plan.

Japan

Directors met in July 1995 to discuss the Fund’s Article IV consultation with Japan against a background of a weak recovery from the recession that bottomed out in the fourth quarter of 1993 (Table 6), Output grew at an average annual rate of only¾ of 1 percent from the fourth quarter of 1993 through the first quarter of 1995, compared with average growth of 5½ percent in past recoveries. The main factor underlying the modest turnaround in activity was a reduced pace of decline in private fixed investment. Growth in private consumption rose only marginally despite income tax cuts implemented in mid-1994. While private spending picked up, the stimulus provided by higher government spending moderated, as public investment plateaued at a high level in mid-1994 before dropping sharply in the first quarter of 1995.

Table 6JAPAN: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in July 1995; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP1.1–0.20.50.4
Unemployment rate (in percent)2.22.52.93.2
Consumer price index1.71.30.7–0.2
External economy
Exports, f.o.b. (in billions of U.S. dollars)339.7360.9395.6442.9
Imports, c.i.f. (in billions of U.S. dollars)233.0240.7274.7336.1
Current account balance (in billions of U.S. dollars)2117.6131.4129.1127.3
Current account balance
(in percent of GDP)3.23.12.82.4
Net direct investment (in billions
of U.S. dollars)–14.5–13.6–17.0
Net securities (in billions of U.S. dollars)–26.2–62.7–48.9
Overall balance (in billions of U.S. dollars)–1.423.5–2.3
Real effective exchange rate (relative normalized unit cost; 1990 = 100)109.9128.9138.0
Total international reserves minus gold
(in billions of U.S. dollars)71.698.5125.9
Financial variables
General government balance
(in percent of GDP)1.5–1.4–3.1–3.7
General government balance excluding
social security (in percent of GDP)–2.0–4.9–6.5–7.0
Gross national saving (in percent of GDP)34.333.131.731.1
Gross domestic investment
(in percent of GDP)31.129.928.828.8
Broad money (M2 plus CDs,
period average)0.61.12.1
Three-month CD rate (average)4.32.82.1
Official discount rate (end of period)3.21.81.8

Projected.

Data for current account balance are on the basis of the 1995 edition of the Balance of Payments Statistics of Japan.

Projected.

Data for current account balance are on the basis of the 1995 edition of the Balance of Payments Statistics of Japan.

The unemployment rate rose in late 1994 to the previous peak of 3 percent reached briefly in 1987, marking a large swing at the 2 percent level in early 1992. Unemployment subsequently increased to slightly over 3 percent in April and May 1995. Simultaneous declines in the ratio of job offers to seekers and in total hours worked provided additional signs of weakness in labor markets.

Following its sharp appreciation from mid-1992 to mid-1993, the yen was broadly stable in effective terms through early 1995, as a further mild rise against the dollar was accompanied by a fall against European currencies. From mid-February through mid-April 1995, however, the yen rose by another 15 percent in effective terms. The cumulative increase of about 50 percent since mid-1992 had taken the yen well above historical trends.

Reflecting large margins of excess capacity and the effects of yen appreciation, the consumer price index rose by only ¾ of 1 percent in 1994. Disinflation continued, and slight deflationary pressure appeared subsequently, as the level of the consumer price index at the end of the first quarter of 1995 stood ¼ of 1 percent below the previous year’s level. At the end of the first quarter of 1995, citing downside risks to the recovery, the Bank of Japan eased monetary poliy through a reduction in the overnight call rate. On the basis of the overall judgment of economic and Financial development including a further rise in the yen and a drop in equity prices, the Bank of Japan decided to ease monetary conditions further in April, by cutting the official discount rate to 1 percent, a new low, and encourage a further reduction in the short-term money market rate.

The current account surplus, which had risen to over 3 percent of GDP in 1992 and 1993, declined to 2.8 percent in 1994 and then to 2.4 percent in the first four months of 1995. While the pickup in domestic demand was modest, effects of structural changes in industry and trade patterns and the lagged effects of earlier yen appreciation boosted import volume growth to an annual rate of over 15 percent during late 1994 and early 1995. The fiscal position deteriorated substantially between 1991 and 1994 as the overall balance shifted from a surplus of 3 percent of GDP to a deficit of an equivalent size. Excluding social security, the deficit rose to almost 7 percent of GDP in 1994, approaching the historical peaks reached in the late 1970s.

In their review, Directors noted that the appreciation of the yen, the drop in equity prices, and strains in the financial system had clouded the prospects for a revival of activity in Japan. They welcomed the fiscal and monetary measures introduced over the previous few years to support activity, including the first supplementary budget of 1995 and the reduction in short-term interest rates. Nevertheless, most Directors believed that, despite the limited scope for action, the emergence of new risks to the outlook justified further measures to support activity until the recovery was firmly established.

Directors observed that, notwithstanding the low level of nominal interest rates, monetary conditions had effectively tightened, owing to the large appreciation of the yen, which had become clearly overvalued in terms of fundamentals. Accordingly, a number of Directors advocated further reductions in short-term interest rates—including a cut in the official discount rate. In addition, some Directors called for providing additional liquidity to the banking system and unsterilized intervention in exchange markets to counteract upward pressures on the yen. Other Directors, however, doubted whether a further easing of monetary policy would be effective in stimulating demand, given the already low level of interest rates and strains in the financial system. Many Directors agreed that action by Japan should be complemented by appropriate policies in its economic partners.

Board members broadly agreed that the past deterioration in the structural fiscal balance called for a resumption of fiscal consolidation once the recovery was well established. Many Directors emphasized that macroeconomic stimulus should be combined with comprehensive structural reforms, stressing that it was in Japan’s national interest to push forward ambitiously the agenda for structural reform and deregulation.

Directors noted that Japan’s current account surplus was primarily a macroeconomic phenomenon, and emphasized that it was in Japan’s interest to enhance market access through measures to reduce barriers to trade. They also urged that measures to address the strains of the financial system be implemented without delay.

Directors commended Japan’s role as the world’s largest provider of financial assistance to developing countries, and also paid tribute to Japan as a key contributor to the Fund’s enhanced structural adjustment facility (ESAF).

Germany

The Board concluded the 1995 Article IV consultation with Germany in August 1995, when the economy was in its third year of recovery and output had recovered to well above its pre-recession peak. The recession bottomed out in the first half of 1993, and GDP grew by an unexpectedly high 3 percent in 1994. Industrial surveys suggested that growth continued in 1995, albeit at a slightly slower pace than during 1994. (See Table 7.)

Table 7GERMANY: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in August 1995; annual percent change unless otherwise noted)
19921993199419951
Domestic economy (western Germany)
GDP (percent change at 1991 prices)1.8–1.72.32.5
Unemployment rate (in percent of labor force)5.87.38.38.2
Consumer price index4.04.13.02.2
Domestic economy (eastern Germany)
Real GDP7.85.89.29.0
Unemployment rate (in percent of labor force)14.714.814.612.9
Consumer price index11.18.93.32.6
External economy
Exports, f.o.b. (in billions of deutsche mark)671.6632.6690.2
Imports, f.o.b. (in billions of deutsche mark)630.2566.9607.8
Current account balance (in billions of deutsche mark)–33.7–25.8–33.4–26.6
Direct investment, net (in billions of deutsche mark)–26.8–23.7–28.7
Securities transactions, net (in billions of deutsche mark)45.3177.3–44.6
Capital account balance (in billions of deutsche mark)90.36.157.1
Real effective exchange rate4.08.8–0.2
Foreign exchange reserves (in billions of deutsche mark)141.4120.1113.6
Financial variables
General government balance
(in percent of GDP)–2.9–3.3–2.5–2.5
Gross national saving
Gross national investment
Money and quasi-money (M3; percent change in annual average)8.58.28.5–0.62
Three-month money market rate
(period average, in percent)9.57.25.34.83
Yield on government bonds
(period average, in percent)8.06.36.77.04

Projected.

Average January-June.

Average January-May 1995 compared with average January-May 1994.

Average January-May.

Projected.

Average January-June.

Average January-May 1995 compared with average January-May 1994.

Average January-May.

As in past cycles, exports led the way out of the recession. They were boosted initially by growth in the United States, the United Kingdom, and some developing countries, and later by the recovery in the rest of continental Europe. Export growth was also underpinned by important restructuring efforts in industry, which yielded large productivity gains. Domestic demand had also begun to revive, with investment becoming the second engine of growth. By contrast, private consumption, weighed down by tax increases and restrained growth in wages, remained sluggish. Public consumption was held back by fiscal consolidation.

Owing to industrial restructuring, unemployment continued to rise well into the economy’s recovery phase and then declined slowly as the recovery progressed. In western Germany, unemployment reached a peak of 8.3 percent in May 1994, and job losses continued as employment fell 1.3 percent in 1994 before finally appearing to stabilize in April 1995. After falling by 12.8 percent in 1992 and by a further 3 percent in 1993, employment appeared to reach its trough around the end of 1993 in eastern Germany, and unemployment fell noticeably between the first half of 1994 and the first half of 1995.

Consumer price inflation, which had proved stubborn during the recession, eased gradually to an annualized rate of about 2 percent by the last quarter of 1994. Consumer price inflation in eastern Germany, which was for years well above the western German inflation rate, continued to approach that of the west. In the first half of 1995, eastern German consumer price inflation ran at levels comparable to, or below, those of western Germany.

Further progress was made in 1994 toward correcting the fiscal policy imbalances induced by unification. Through a combination of tax measures, expenditure savings, and higher-than-expected growth, the general government deficit was cut to 2½ percent of GDP in 1994, almost 1 percent of GDP below the level initially planned. However, in 1995 the deficit increased to 3.5 percent of GDP.

In their discussion, Directors commended the financial consolidation implemented by the German authorities. Directors noted that the financial imbalances that had initially arisen after unification had been greatly reduced, as had inflationary pressures. Considerable progress had been made in reducing fiscal deficits. Nevertheless, they considered that important challenges remained, most notably in the form of persistent structural problems.

Directors supported the authorities’ broad objectives for fiscal policy in the medium term, comprising both a further reduction in the fiscal deficit and a lowering of Germany’s heavy tax burden. They believed it was important to be ambitious on both those counts, particularly in view of the fiscal pressures that were likely to ensue from the prospective aging of the German population. A further reduction in the deficit would also relieve the burden on monetary policy as the recovery matured, and increase the availability of capital, both at home and abroad.

Directors commended the efforts made in the draft budget to limit the increase in the federal deficit and to set the stage for a further reduction in the general government deficit.

Directors welcomed the substantial, albeit gradual, relaxation of monetary conditions that had taken place between 1992 and 1994, and that had been made possible in large part by the continued progress in fiscal consolidation. They observed that the sharp appreciation of the deutsche mark in early 1995 had compounded the difficulties of policymaking.

Directors welcomed the progress made in addressing important structural problems, including through deregulation, privatization, and reform of the financial system, but stressed that much remained to be done. They expressed special concern that there had been little progress on structural unemployment, which had become Germany’s most pressing problem. They considered that, ultimately, Germany would have to tackle the difficult problems of the relationship between generous social protection and low wage differentiation on the one hand, and high structural unemployment on the other.

Several Directors commended the authorities for their large-scale assistance to economies in transition, and hoped that they would reverse the decline in official development assistance observed in the preceding few years.

France

The Board considered the 1995 Article IV consultation with France in October 1995, as recovery from the deep recession of 1993 slowed from the pace set in 1994. (See Table 8.) Real GDP increased by an average of 3 percent in 1994, but the rate of growth declined to an annualized rate of 2¼ percent in the first half of 1995. The recovery was triggered mainly by an upturn in partner country demand, which led to a resurgence of export growth. After rapid growth in late 1994 and early 1995, exports slowed sharply in the second quarter in line with the weakening of growth in European partner countries.

Table 8FRANCE: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in October 1995; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP1.3–1.52.92.9
Unemployment rate (in percent of total labor force)10.311.612.411.7
Consumer price index2.42.11.72.1
External economy
Export volume4.9–0.45.86.9
Import volume1.1–3.46.85.7
Current account balance
(in billions of francs)20.459.554.162.0
Net direct investment
(in billions of francs)–16.8–0.10.3
Net portfolio investment
(in billions of francs)187.116.9–308.2
Capital balance (in billions of francs)2–132.5–79.750.2
Effective exchange rate (MERM)33.70.50.74.24
Net change in official reserves
(in billions of francs;–= increase)5.330.9–13.9
Financial variables
General government balance
(in percent of GDP)–4.0–6.1–6.0–5.2
Gross national saving
(in percent of GDP)19.918.118.9
Gross national investment (in percent of GDP; stockbuilding included)19.817.218.4
Broad money (M3)5.3–3.22.04.65
Three-month interbank money rate10.48.45.86.85
Government bond yield8.66.87.27.75

Projected.

Equals long-term capital plus short-term nonofficial capital, including errors and omissions.

Based on the Fund’s multilateral exchange rate model; a positive figure indicates an appreciation.

Average to September 15, 1995; percent changes calculated relative to the average for the previous year.

Second quarter of 1995 over the same period in 1994.

Projected.

Equals long-term capital plus short-term nonofficial capital, including errors and omissions.

Based on the Fund’s multilateral exchange rate model; a positive figure indicates an appreciation.

Average to September 15, 1995; percent changes calculated relative to the average for the previous year.

Second quarter of 1995 over the same period in 1994.

Nonfarm employment began to rise in the course of 1994, and grew by 2.2 percent in the 15 months to June 1995. Unemployment, however, continued to increase even after the turning point in output and employment had been passed, because of increased labor force participation. The unemployment rate held steady near its record rate of 12½ percent for most of 1994 but subsequently declined to 11.4 percent by July 1995.

Consumer price inflation, which was relatively low even at the peak of the previous cycle, fell further during the recession and the early stages of the recovery. Although the increase in the tax on petroleum products at the beginning of 1995 and the higher value-added tax rate that went into effect during the summer pushed up the price level, the effect was temporary. The low rate of underlying inflation reflected mainly the slow growth of wages and the persistence of a substantial output gap.

The external current account remained in surplus at about ¾ of 1 percent of GDP in 1994, as an expansion in foreign demand for French exports outpaced the increase in domestic demand for imports. The current account continued in surplus in early 1995, accompanied by further net outflow’s of long-term capital, which had also been substantial in 1994, In 1994 and early 1995, external competitiveness was broadly unchanged; the nominal and real effective exchange rates showed only a small appreciation.

France’s general government deficit reached unprecedented levels in peaking at 6.1 percent of GDP in 1993 and staying at 6 percent in 1994. The new Government formed after the May 1995 presidential elections reaffirmed its commitment to fiscal consolidation. As a first step, the Government prepared a supplementary budget for 1995 aimed at correcting slippages in the central government deficit from its initial budget target; on this basis, the authorities expected the general government deficit to decline to about 5 percent of GDP in 1995.

In their review, Directors noted the continued economic recovery in France and the decline in unemployment from the record level reached in 1994. They also commended France on the progress made during the past decade toward establishing low inflation. However, Directors observed that the French authorities had, unfortunately, not made the best use of these favorable circumstances to correct two stubborn problems. These were the fiscal deficit and high unemployment, whose main underlying causes were the generosity and insufficient targeting of the welfare system, and labor market rigidities.

Directors noted with concern that in recent years the general government deficit had risen sharply and could still remain above 5 percent of GDP in 1995. They stressed that early announcement and implementation of a credible program of fiscal consolidation was essential to secure a lasting reduction in interest rates, to boost domestic and foreign confidence in the authorities’ overall strategy, and to promote durable financial stability and sustained economic expansion. Although the draft 1996 budget for the central Government presented in September was a step in the right direction, much more had to be done. Directors therefore urged France to announce urgently measures to reduce the general government deficit to below 3 percent of GDP in 1997.

In the structural area, several Directors recommended more vigorous privatization and deregulation policies to promote domestic competition and public enterprise reform. Directors emphasized that labor market policy would need to address squarely the basic causes of high unemployment among the unskilled—namely, a high minimum wage with attendant high nonwage labor costs, which together price many untrained workers out of the market, and generous minimum social benefits, which reduce work incentives.

Directors commended the Bank of France for its skillful conduct of monetary policy. However, they observed that the central bank’s room for maneuver in the interest rate area remained limited. Rapid progress on the fiscal front was urgently required if the credibility of the exchange rate anchor was to be safeguarded and if interest rates were to be lowered to a level more compatible with the domestic priority of job creation.

Directors commended France on its generous official development assistance, which at 0.65 percent of GDP was higher than in most other industrial countries. They hoped that these flows would be maintained even as France attempted to come to terms with its public sector deficit.

At the end of October, following the consultation, the French authorities announced that the achievement of convergence in accordance with the treaty on European Monetary Union would henceforth be the principal objective of macroeconomic policy. To this end, the Government indicated that a comprehensive deficit-reduction program would be adopted, with the aim of reducing the general government deficit to 4 percent of GDP in 1996 and 3 percent in 1997. As a first step, the Government in November presented a substantial reform of social security, with an emphasis on restraining the growth of health care expenditure.

United Kingdom

The Article IV consultation with the United Kingdom was concluded by Directors in October 1995, as the pace of U.K. economic activity moderated and the recovery entered a more mature phase. From an annual rate of 4 percent in the first half of 1994, real GDP growth slowed to just over 2 percent in the first half of 1995, owing to both policy tightening and an easing in overseas growth. Job growth and the decline in unemployment also slowed, with the latter falling to about 8 percent from a peak of 10.5 percent in 1992. (See Table 9.)

Table 9UNITED KINGDOM: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in October 1995; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP–0.52.23.82.7
Average unemployment rate
(in percent of labor force)9.710.39.38.3
Retail price index24.73.02.42.9
External economy
(in billions of pounds)
Exports107.3121.4134.5148.1
Imports120.4134.8145.1158.7
Current account balance–9.8–11.0–1.7–7.4
Net direct investment–1.7–7.5–9.7–8.7
Net portfolio investment–3.8–37.750.4–10.6
Basic balance–15.3–56.239.0–28.3
Nominal effective exchange rate
(period average, 1990 = 100)96.9988.9889.2585.333
Official reserves (end of period)27.529.028.129.3
Financial variables
General government receipts4
(in billions of pounds)223.0231.0250.8278.2
General government expenditure4
(in billions of pounds)267.0281.3296.1305.6
Gross national saving
Gross national investment
M02.44.96.46.25
M43.15.04.26.15
Three-month interbank interest rate9.65.95.56.76
Ten-year government bond yield9.17.58.27.96

Projected.

Excluding mortgage interest.

January-September average.

Outturn figures from Central Statistical Office for fiscal years 1992/93, 1993/94, and 1994/95, and from proposed budget in Financial Statement and Budget Report for fiscal year 1995/96.

January-August average.

September.

Projected.

Excluding mortgage interest.

January-September average.

Outturn figures from Central Statistical Office for fiscal years 1992/93, 1993/94, and 1994/95, and from proposed budget in Financial Statement and Budget Report for fiscal year 1995/96.

January-August average.

September.

Between 1993 and 1994, the underlying source of growth shifted from private consumption to exports. Mainly because of a tightening of fiscal policy, a sustained real exchange rate depreciation, and buoyant world export markets, a recovery initially supported by consumption became an expansion increasingly driven by export and investment demand in late 1994 and early 1995. Higher interest rates, a subdued housing market, and a squeeze on disposable income restrained consumption expenditures from the second half of 1994.

Fiscal policy was conducted in the context of the Government’s Medium-Term Financial Strategy. The November 1994 budget sought to reduce the public sector borrowing requirement from 6 percent (excluding privatization revenues) in 1994/95 to 3.4 percent in 1995/96, aiming at balance by 1998, As an integral part of the Medium-Term Financial Strategy, monetary policy has since late 1992 been oriented to a quantified target for underlying inflation—the lower half of a 1 to 4 percent range by the second quarter of 1997 at the latest and beyond that to continue to achieve 2½ percent or less. Short-term interest rates were raised by 150 basis points in three equal steps between September 1994 and February 1995. Underlying inflation reached its trough in late 1994 at an annual rate of 2 percent, but then rose in response to import cost increases; commodity prices rose sharply during 1994, and the impact of their decline in early 1995 was partly offset by the depreciation of sterling.

The external current account moved close to balance in 1994, supported by strong exports and buoyant investment income. The pickup in world trade in 1994 was partly responsible for the strength in exports, but export market share also improved. Export growth leveled off in early 1995 in response to softer demand in some key markets. After a period of relative stability in most of 1993 and 1994, the nominal effective exchange rate for sterling depreciated by 6 percent in the first half of 1995 before stabilizing.

In their review, Directors noted that the United Kingdom’s economic upswing had continued, with growth moderating to a sustainable pace, and domestic cost pressures had remained subdued despite the further decline in unemployment. Directors viewed the conduct of U.K. policies in the past year as clearly adhering to the principles underlying the Madrid Declaration, pointing to the authorities’ medium-term policy framework as a key ingredient in the favorable performance. Directors recommended that, to achieve lasting success, the authorities maintain the established medium-term course and resist any pre-election pressures for policy easing. Directors emphasized that the November 1995 budget would need to play a crucial role in demonstrating firm adherence to the medium-term strategy.

Directors also highlighted the significance of fiscal policy for longer-term economic performance, and several speakers advocated a clearer economic articulation of medium-term fiscal policy. Some Directors noted that, as U.K. rates of saving, investment, and potential output growth still appeared low relative to some other industrial countries, implementation of announced plans for medium-term fiscal consolidation was critical to raising the rate of national saving and improving growth performance.

Directors considered that inflation targeting, which had triggered a pre-emptive tightening of monetary policy, had served the economy well. They believed, however, that the authorities’ presentation of the target could have been more direct, and advised that inflation targeting be kept simple. Directors welcomed the transparency of the monetary policy framework, observing that the publication of minutes had enhanced accountability and improved policy formation. Some Directors recommended further progress toward independence of the Bank of England, in particular by transferring to it responsibility for interest rate policy. Given the comfortable external and competitive positions. Directors felt that an appreciation of the pound sterling’s effective exchange rate toward early 1995 levels would be welcome.

Several Directors commended the authorities for overcoming structural impediments in the economy. They noted that labor market reforms were succeeding in terms of both employment and wage behavior; although unemployment was high and long-term unemployment remained a particular concern, it did begin to fall in 1995. The authorities were encouraged to expand initiatives to enhance the labor market prospects of the long-term unemployed.

Italy

Directors met in March 1996 to conclude the Article IV consultation with Italy, against the background of a strong but unbalanced recovery in which export growth was the driving force. (See Table 10.) Real GDP growth accelerated from 2.2 percent in 1994 to about 3 percent in 1995, as the weakness of the lira and the further decline in unit labor costs sustained further gains in export market shares and boosted the current account surplus to 2½ percent of GDP. Fiscal cutbacks restrained public consumption, and private consumption remained sluggish as wage moderation and the contraction in dependent employment slowed total compensation growth. Employment and income uncertainty, along with rising inflation, also depressed consumer confidence and supported precautionary saving. Domestic demand was thus subdued even though activity was buoyant.

Table 10ITALY: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in March 1996; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP0.7–1.22.23.2
Unemployment rate (in percent of total labor force)210.710.211.212.0
Consumer price index5.24.54.05.4
External economy3
Export volume3.88.910.713.6
Import volume3.4–10.211.412.9
Current account balance
(in percent of GDP)–2.31.11.52.5
Net direct investment (in billions of lire)–3,373–5,469–4,6321,589
Net portfolio investment
(in billions of lire)1,288113,485–8,26444,531
Capital account balance
(in billions of lire)10,31714,799–22,157
Real effective exchange rate–2.9–14.9–6.2–8.3
Total gross official reserves (in millions of U.S. dollars, end of period)50,81851,13858,60760,475
Financial variables
General government balance
(in percent of GDP)4–9.5–9.6–9.0–7.1
Broad money55.98.21.92.1
Six-month treasury bill rate614.410.59.110.9
Ten-year treasury bond rate613.311.210.611.6

Projected.

Excluding workers in Wage Supplementation Fund.

Volumes are customs basis; current account is balance of payments basis.

Includes interest accruing on zero-coupon bonds.

Growth rate used for target monitoring; that is, moving average of last three months.

In percent, gross.

Projected.

Excluding workers in Wage Supplementation Fund.

Volumes are customs basis; current account is balance of payments basis.

Includes interest accruing on zero-coupon bonds.

Growth rate used for target monitoring; that is, moving average of last three months.

In percent, gross.

The combination of a weak lira and the gathering recovery reinforced other factors, such as higher world commodity prices and indirect tax increases, to boost inflation from a 25-year low of 3.8 percent in mid-1994 to an average of 5.4 percent in 1995. Underlying inflation, as measured by consumer prices adjusted for increases in indirect taxes and terms of trade changes, remained relatively contained at about 4 percent. This owed much to the restraint exerted by the July 1993 agreement on wage bargaining, which continued to limit increases in minimum contractual wages to the official inflation objective of 2½ percent. The agreement thus implied a more stringent wage policy than expected, so that, with real wages declining and productivity increasing, unit labor costs fell for the second consecutive year in 1995.

The overall deficit of the state sector narrowed to 7.3 percent of GDP in 1995 from 9½ percent of GDP in 1994, compared with an initial budget target of 8 percent of GDP. With the primary surplus widening to 3.4 percent of GDP, the rise of the ratio of public debt to GDP was halted. The improvement in recent years stemmed fully from a decline in primary spending amounting to 4 percentage points of GDP between 1993 and 1995. The level of primary spending is currently some 3½ percentage points of GDP below the European Union average, while the revenue-to-GDP ratio is broadly in line with that observed in the rest of the European Union.

Monetary policy remained cautiously restrictive. Beginning in mid-1994, the Bank of Italy raised official interest rates in three steps, by a cumulative 200–250 basis points, to quell inflationary tendencies, and pushed up money market interest rates in reaction to recurrent exchange market tensions. M2 expanded by 2.1 percent on a three-month moving average to December 1995.

In their review, Directors commended Italy’s progress in fiscal consolidation, which had been achieved under difficult political circumstances. The correction in the public finances in 1995 had been better than targeted, and had begun to reverse the previously inexorable rise in the debt ratio. Directors considered pension reform to be another concrete and important achievement in 1995, and urged the authorities to build on these gains.

Directors noted that the lira’s weakness had led to an unbalanced recovery that exacerbated existing structural imbalances between regions. They considered that a strengthening of the lira, following fiscal consolidation, would likely be accompanied by a decline in interest rates that would offset the normal contractionary effects of fiscal consolidation and of the exchange rate appreciation. Against that background, Directors called for a quickening of the pace and structural content of fiscal consolidation, agreeing that it was crucial that the commitment to consolidation be credible to the markets. Most Directors were of the view that Italy should strive to meet the Maastricht criteria even in 1997, a year earlier than had been anticipated at the end of 1994. To this end, they urged the authorities to adopt a set of front-loaded measures to achieve the general government deficit criterion of 3 percent of GDP by 1997. They agreed that, as in the authorities’ plans, as much of the fiscal adjustment as possible should take the form of durable measures on the expenditure side.

Directors noted that a credible acceleration of fiscal adjustment would create a more favorable setting for the conduct of monetary policy and would likely result in a further appreciation of the lira. They observed that, in the absence of a renewed fiscal effort, monetary policy would have to bear a heavy burden to attain the desired reduction in inflation. Under those circumsrances, policy would need to remain tight, and the Bank of Italy would need to stand ready to act if fiscal policy slippages threatened to undermine the inflation objective.

Directors believed that a new impetus was needed in structural reform. They stressed the need for reform of the budgetary process to bring macroeconomic constraints fully to bear on spending, increase accountability, and enhance transparency in budgetary documents. They noted that passage of the law on regulatory authorities had set the stage for the privatization of public utilities, which should now proceed at an even quicker pace, and also advised that a high priority be given to privatization of the banks owned by public foundations. They were concerned about the persistence of unemployment, the duality between north and south, and the high youth and long-term rates of unemployment and stressed the need, inter alia, for greater regional and industrial wage differentiation.

Canada

The Board considered the staff report for the 1996 Article IV consultation with Canada in April 1996. The strong economic expansion during 1993 and 1994 slowed in 1995. (See Table 11.) By the time of the 1995 consultation, the slowdown in real GDP growth in 1995 was considerably greater than had been anticipated earlier. The shortfall in growth was mainly due to the larger-than-expected effects of the rise in interest rates that began in late 1994, weak consumer and business confidence, and the sharpness of the slowdown in the United States during the first half of 1995, which limited export growth.

Table 11CANADA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in April 1996; annual percent change unless otherwise noted)
19931994199519961
Domestic economy
Real GDP2.24.62.21.9
Unemployment rate (in percent of labor force)11.210.49.59.6
Consumer price index
(annual average)1.80.22.11.3
External economy
Export volume11.214.712.36.6
Import volume11.113.69.83.8
Current account balance (in billions of Canadian dollars)–28.8–22.3–13.1–5.3
Net direct investment (in billions of Canadian dollars)–1.11.78.8
Net portfolio investment (in billions of Canadian dollars)27.112.520.2
Real effective exchange rate (based on unit labor costs)–8.5–5.5–6.6
Gross official international reserves
(in billions of U.S. dollars)12.812.515.2
Financial variables
General government balance
(in percent of GDP)–7.3–5.3–4.2–2.4
Gross domestic saving (private, in percent of GDP)17.818.018.416.5
Gross domestic investment (private, in percent of GDP)15.816.315.416.3
M2 (money and quasi-money, end of period)3.12.74.0
Three-month treasury bill rate
(in percent)4.85.57.05.1
Ten-year government bond rate
(in percent)7.28.48.17.7

Projected.

Projected.

Real GDP growth was near zero during the first half of 1995, owing to steep declines in net exports and construction, as well as to a slowdown in personal consumption expenditure. The economy recovered in the third quarter as net exports grew strongly, but slowed again in the fourth quarter because of weakness in consumption, inventory accumulation, and residential investment. Employment growth fell from 3 percent in 1994 to 0.8 percent during 1995 as private sector employment growth slowed and public sector employment contracted. The participation rate continued to decline, so that the unemployment rate fell from a cyclical peak of 11.9 percent at the end of 1992 to 9.6 percent at the end of 1994 and remained little changed through 1995 and into 1996.

The rate of core consumer price inflation rose modestly from 1.6 percent during 1994 to 1.9 percent during 1995, owing to the lagged effects of the depreciation of the Canadian dollar and a sharp increase in commodity prices in the first half of 1995. The external current account deficit narrowed from 3 percent of GDP in 1994 to 1.7 percent of GDP in 1995 as the value of exports grew strongly, a trend related to higher commodity export prices, earlier depreciation of the Canadian dollar, declining unit labor costs for manufactures, and stronger import demand in the United States as the year progressed.

During much of 1995 and early 1996, an appreciating Canadian dollar, weaker-than-expected economic activity, and moderating inflationary pressures allowed the Bank of Canada to ease monetary conditions. From early May 1995 to end of March 1996, the Bank of Canada lowered its target range for the overnight rate by 300 basis points.

The 1996/97 budget presented to Parliament in March 1996 confirmed government targets for the federal budget deficit equivalent to 3 percent of GDP in 1996/97 and 2 percent of GDP in 1997/98, and restated the authorities’ longer-term commitment to a balanced budget. The budget’s measures focused mainly on spending curs designed to reduce the nominal level of noninterest spending by an average annual rate of 2.5 percent during the next three years. To achieve this objective, the budget introduced further cuts in defense, international assistance, social and cultural programs, as well as cuts in agricultural and transport subsidies and in government operating costs.

In their review, Directors commended the authorities for the progress made in implementing their strategy since the last Article IV consultation in May 1995. Inflation had been contained and was projected to remain low, the federal fiscal deficit had continued to decline, the external current account deficit had narrowed, and progress had been made in reforming a number of key social programs. Nevertheless, Directors considered that it remained important to sustain the momentum of adjustment to put the high debt-to-GDP ratio on a clear downward path, as the high level of government indebtedness left the economy vulnerable to shifts in market confidence and to domes-tie and external shocks.

Directors noted that, in the March 1996 budget, the Government had reaffirmed its commitment to fiscal deficit reduction and was likely to meet its targets for a reduction of the federal deficit, but they stressed the importance of sustaining fiscal consolidation over the medium term. Although the federal debt-to-GDP ratio is expected to decline in 1997/98, it is still high by international standards and leaves the economy vulnerable to adverse interest rate developments. Most Directors agreed that the focus of fiscal consolidation should remain on expenditure cuts in areas that would also support structural reform. The Board welcomed the improvements in the budgetary process to target spending cuts across a broad range of programs and services.

Directors endorsed the authorities’ efforts to reform the Unemployment Insurance system, although some Directors noted that deeper cuts in benefits could help to reduce structural unemployment in Canada. Steps taken to address the long-term sustainability of the system of government benefits to the elderly were welcomed by Directors. It was noted, however, that the measures would not begin to yield fiscal saving for many years. Directors also expressed concern about the large and growing unfunded liability of the Canada Pension Plan, which would require substantial increases in contribution rates, or considerable reductions in benefits, or both. Changes in the Plan are presently under discussion.

Directors commended the authorities for their continued success in maintaining inflation at a low level and for the steps that had been taken to improve the transparency of the monetary policy process. They generally agreed that the easing of monetary conditions since early 1995 had been appropriate in light of favorable price developments and the considerable slack prevailing in the economy.

Directors considered that Canada’s consistent support for free trade was commendable and welcomed, in particular, the recent actions to reduce agricultural subsidies, accelerate Uruguay Round tariff cuts, and make the tariff system simpler and more transparent. The liberalization of internal trade was also welcomed. The authorities were commended for the high quality of their official assistance to developing countries, and were encouraged to meet their commitment to the 0.7 percent of GDP target for official development assistance.

Smaller Industrial Countries

During the 1996 financial year, the Fund concluded Article IV consultations with nearly all of its 16 smaller industrial country members. Vigorous economic performance characterized a number of countries, among them Australia, Austria, Ireland, Luxembourg, New Zealand, and Norway. Directors found evidence of an investment-led recovery in economic activity in Greece, and they welcomed Finland’s return to a low-inflation growth path. They agreed that a moderation of growth was appropriate in New Zealand in view of that country’s high degree of capacity utilization and the sharp drop in the unemployment rate. They also noted that Belgium’s economic growth had slowed markedly in parallel with developments in neighboring countries, and that the Swiss recovery’ was proceeding at a disappointingly slow pace.

For many of these countries—with New Zealand a notable exception—the fiscal position was a principal concern. Directors urged countries to seize opportunities afforded by economic expansions to pursue needed fiscal consolidations, but they also called for perseverance with fiscal discipline in the face of slower growth so that progress could be secured. Activity in a small economy, such as Luxembourg, was susceptible to large fluctuations—a fact that further bolstered the case for a prudent public expenditure policy, the Board observed. They recommended decisive deficit reduction in Finland to stabilize and reverse the rising central governmental debt ratio and urged Austria to step up the pace of its fiscal retrenchment. Directors commended the Irish authorities for containing their fiscal deficit and reducing the ratio of high public sector debt to GNP, but they regretted that the opportunity afforded by strong economic growth to accelerate a reduction in the budget deficit had not been used to full advantage.

Directors believed that further fiscal consolidation was indispensable in Belgium to safeguard that country’s hard-currency policy and participation in EMU. They welcomed the medium-term fiscal consolidation plan of the new Government in Australia and noted that it would be important to take steps to raise private saving. Directors welcomed the progress on fiscal consolidation that Greece had made since its last consultation but cautioned against premature relaxation of financial policies, underscoring the need for fiscal discipline to alleviate the burden currently borne by monetary policy and to counter the adverse effects of existing large fiscal imbalances.

High tax burdens in many of these countries effectively limited the scope for revenue-enhancing measures, although Directors emphasized the importance of a further strengthening of tax administration in Portugal and of expanding the tax base and improving tax compliance in Greece. For most countries, fiscal consolidation would need to rely on a mix of measures that could permanently reduce expenditures. This could entail efforts to contain the wage bill, reduce subsidies and transfers, and in some instances shrink the role of government in the economy. Such steps were recommended in Norway’s case, for example, to facilitate its transition, over the longer term, to a competitive post-oil economy.

Directors noted that a reduced ratio of public debt to GNP would provide policymakers with greater flexibility in conducting fiscal policy and in dealing with aging populations and the resultant pressures on pension systems. They commended Finland’s success in reaching agreement on reform of its pension system, and supported Luxembourg’s initial steps to contain the cost of public sector pensions. They noted that pension reform remains a major concern for many of the smaller industrial countries over the medium term.

Directors commended the credibility of monetary policy in many of the smaller industrial countries, singling out New Zealand’s monetary policy framework for special praise. These policies had been effective in containing inflationary pressures throughout New Zealand’s economic upswing, and Directors believed that a continued tight monetary policy was appropriate. They also recommended a tightening of monetary policy in other countries, such as Ireland, that were committed to low inflation rates, adding that in a number of countries tighter fiscal policy would prove a useful complement to both monetary and exchange rate policy. Directors welcomed the tightening of monetary conditions in Iceland, and they encouraged authorities to tighten them further to bolster the low level of reserves. Greece’s exchange-rate-based monetary policy had been effective in halving inflation from its peak in 1990, but its experience with capital inflows reflected the limits of relying exclusively on monetary policy to secure further reductions in inflation. Directors also commended Portugal’s prudent monetary stance, but they urged that monetary and exchange rate policies be more strongly supported by appropriate fiscal policies.

Directors complimented a number of countries on their pursuit of credible exchange rate policies, noting that for several of the European countries the hard-currency policy had well served their needs. They commended Finland for beginning to build up a track record of exchange rate stability. The Board observed that Iceland’s stable but adjustable exchange rate policy had contained domestic inflationary pressures and maintained competitiveness, but they expressed concern over continued private capital outflows and a further decline in reserves.

The persistent appreciation of the Swiss franc reflected, in the view of Directors, the high saving rate and the attraction of Switzerland as a safe haven. Coupled with Switzerland’s continued integration into the European and global economies, the appreciation made it imperative that the country accelerate the structural adjustment of its economy and increase the flexibility and adaptability of its nontradables sector if a satisfactory level of employment was to be sustained over the medium term.

Directors cited possible tension between buoyant oil revenues and efforts to keep the Norwegian krone stable and inflation low, and they noted that a tighter fiscal stance could help alleviate upward exchange rate pressures. Wage behavior posed the greatest risk to inflation in Finland; Directors believed a tightening of monetary policy might be warranted if wage pressures did build up. They also regretted the fiscal concessions made in Iceland in conjunction with a recent review of the general wage agreement and considered that these costs should have been fully offset by new measures.

Directors complimented New Zealand on its sustained implementation of structural economic reforms and the maintenance of stable macroeconomic policies, which had helped it to achieve a higher potential growth rate. They credited extensive deregulation of the labor market for delaying the emergence of generalized wage pressures, facilitating strong employment growth, and encouraging investment in education and training. Stubbornly high unemployment rates had persisted in many of the other economies, however, suggesting that structural issues lay at the root of these problems. Directors welcomed reforms to increase labor market flexibility, such as Finland’s tightened requirements for unemployment insurance, but they agreed that many of these countries would benefit from more vigorous efforts to remove obstacles to job creation. They applauded the decision of the new Australian Government to give labor market reform top priority and welcomed new initiatives aimed at extending competition to public enterprises and other sheltered sectors of the economy.

Directors called on a number of countries, including Portugal, to improve their banking supervision in order to strengthen their financial sectors. They also noted the importance in Iceland of taking steps to further increase the efficiency of the financial sector.

Finally, in keeping with the Fund’s data initiative, Directors reviewed the timeliness and accuracy of the data collected by these countries and encouraged a number of them to undertake improvements in certain areas, including external trade and consumer price data and national income accounts.

Australia

The Board concluded the 1995 Article IV consultation with Australia in March 1996. Since the late 1980s, the Australian economy has been progressively integrated into the global economy through a decline in tariff protection and far-reaching financial deregulation. Against this backdrop, Executive Directors welcomed the generally favorable performance of the Australian economy in recent years, reflected in over four years of sustained growth, much lower inflation, and significant employment gains (see Table 12). However, Directors observed that the Australian economy faced two key structural constraints—the long-term deterioration in the current account position that had resulted in the accumulation of high external indebtedness, and a structurally high unemployment rate. Moreover, Directors were also concerned that demand pressures would spill over to worsen further the external account and rekindle inflation. To address these issues, the authorities have developed a comprehensive policy strategy based on raising national saving, locking in low inflation, and making product and factor markets more flexible.

Table 12AUSTRALIA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in March 1996; annual percent change unless otherwise noted)
1991/921992/931993/941994/95
Domestic economy
Real GDP0.73.24.44.5
Unemployment rate10.311.010.58.9
Consumer price index1.91.01.83.2
External economy
Exports, f.o.b. (in billions of Australian dollars)54.960.063.966.4
Imports, f.o.b. (in billions of Australian dollars)51.159.464.474.7
Current account balance (in billions of Australian dollars)–11.6–14.9–16.7–27.6
Gross direct investment (in billions of Australian dollars)112.5121.9128.6
Portfolio investment (in billions of Australian dollars)127.5122.9126.8
Capital account (in billions of Australian dollars)14.914.313.223.1
Gross external debt (in billions of Australian dollars)191.3208.4205.9223.3
Real effective exchange rate
(1989/90 = 100)89.582.177.378.6
Net international reserves (in millions of U.S. dollars)16.714.015.114.3
Financial variables
General government balance
(in percent of GDP)–4.6–4.7–3.1–2.4
Broad money0.82.31.37.8
Interest rate (ten-year bond)9.98.37.49.9

Directors believed that medium-term fiscal consolidation would be critical in raising national saving, reversing the deterioration in the external accounts, and sustaining growth performance. Directors welcomed the new Government’s aim to achieve underlying budget balance by 1997/98. They generally shared the authorities’ view that fiscal consolidation should focus mainly on the spending side. Directors also noted the decline in private saving and the importance of providing an economic environment that encouraged private saving. The authorities’ commitment to price stability has been supported by the forward-looking and more transparent monetary policy framework.

With demand expected to remain strong, Directors considered that financial policies needed to remain firm to keep domestic costs in check and to ensure that underlying inflation returned to its target range of 2–3 percent. Some Directors believed that there was a case for further monetary tightening, particularly if the economy gave indications of more robust growth. Several suggested that greater specificity of the inflation target might clarify expectations and afford rapid credibility gains as the target was achieved.

In recent years the authorities have undertaken many initiatives to overcome structural impediments in the economy. These have included far-reaching initiatives to extend competition to public enterprises and other sheltered sectors of the economy as well as policies to promote a more flexible and efficient labor market by supporting a gradual shift in the focus of the industrial relations system away from centrally determined awards toward enterprise-based bargaining. Directors commended these, but noted that other challenges, particularly the challenge of reducing unemployment, remained. They observed that significant rigidities in the labor market reduced the effectiveness of enterprise bargaining and heightened the risk that wage settlements could run ahead of productivity improvements. Therefore Directors strongly welcomed indications that labor market reform aimed at facilitating enterprise bargaining would be a top policy priority of the Government. They also urged that attention be given to other potential causes of high unemployment, such as the levels of nonwage labor costs and social welfare benefits that could reduce work incentives. Some Directors also pointed to the need to improve the skills and productivity of workers to enhance external competitiveness.

Directors welcomed the authorities’ continued commitment to liberal trade policies. Some Directors suggested further trade liberalization, especially tariff cuts, to strengthen competition. The authorities were also encouraged to raise their official development assistance.

Austria

When Directors met in May 1995 to discuss its 1995 Article IV consultation, Austria was experiencing a robust economic upturn following a relatively mild recession in 1993. Both foreign and domestic demand was growing vigorously. Private consumption was strengthening, and fiscal policy remained expansionary. Growth in wage earnings continued to decelerate, reflecting the effects of the 1993 stabilization pact between the Government and its social partners. In view of this development and of nearly stable import prices, deceleration in consumer price inflation (3.6 percent in 1993 to 3.0 percent in 1994) remained slow. Nevertheless, profit margins in the service sector increased, while profitability in manufacturing rose to its highest level since the early 1970s.

Monetary policy continued to be guided by the close link of the Austrian schilling to the deutsche mark. Having established the credibility of this policy, the authorities were able to allow monetary conditions to ease. Short-term interest rates remained below those in Germany, The nominal effective exchange rate of the schilling was broadly stable. The external current account deficit, however, widened in 1994 to about 1 percent of GDP because of the strong cyclical rebound in imports and a sizable decline in net earnings from tourism. (See Table 13.) Nonetheless, net capital inflows were sufficient to finance the current account deficit.

Table 13AUSTRIA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in May 1995; annual percent change unless otherwise noted)
199219931994119952
Domestic economy
Real GDP1.8–0.12.73.0
Unemployment rate3.64.24.44.2
Consumer price index4.13.63.02.7
External economy
Exports, f.o.b. (in billions of schillings)487.6467.2512.5560.0
Imports, c.i.f. (in billions of schillings)593.9564.9628.9663.0
Current account balance
(in percent of GDP)–0.1–0.4–1.0–1.1
Direct investment (in billions of schillings)–10.2–5.60.7
Portfolio investment (in billions of schillings)–29.8–20.4–48.3
Capital and financial account balance
(in billions of schillings)21.10.532.0
Real effective exchange rate1.41.8–2.2
Net international reserves (in billions of schillings)–119.0–139.0
Financial variables
General government balance
(in percent of GDP)–3.3–4.6–4.7–4.3
Gross fixed investment1.3–2.15.55.8
Broad money4.24.05.3
Interest rate (six-month interbank rate)9.46.85.2

Preliminary.

Projected.

Preliminary.

Projected.

The underlying position of public finances deteriorated in 1994 for the second year in a row. The structural deficit approached 3 percent of GDP in 1994, reflecting higher expenditures on entitlement programs and shortfalls in receipts from corporation tax and the tax on investment income. Over the two years to 1994, the gross public debt increased by 5 percent to reach 63 percent of GDP.

Directors, welcoming the 1995 Article IV consultation as the first since Austria had joined the European Union, noted with satisfaction the good economic situation in Austria. The economy had revived swiftly from the mild 1993 recession, and strong growth was likely to continue. Unemployment was remarkably low-by European standards. Directors expressed concern, however, about the weakening of public finances, which could only partly be attributed to transitory factors and was worrisome because it coincided with Austria’s assumption of the Maastricht Treaty objectives.

Directors were unanimous in their view that the restoration of a sound fiscal position should be the main policy priority for the next few years. They urged the authorities to step up the pace of fiscal retrenchment in 1996. They emphasized that Austria should use present and prospective economic expansion to lower the general government deficit to below the Maastricht criterion of 3 percent of GDP and to reverse the upward trend in the public deficit ratio to below the 60 percent EMU ceiling. Entitlement programs needed to be cut to reduce the federal deficit.

Directors commended the authorities on the smooth and speedy entry of the schilling into the exchange rate mechanism of the European Monetary System (EMS). At the same time, they emphasized that strict adherence to an ambitious program of fiscal consolidation would be essential to safeguard the link between the schilling and the deutsche mark and to maintain the low interest rate differentials with Germany.

Directors agreed there was scope-to increase competitive pressures, particularly in the sheltered service sector. Similarly, action was called for to reduce undue incentives to early retirement in order to raise labor force participation, to contain nonwage labor costs, and to ensure the long-term viability of the pension system.

Following the consultation, the general government deficit widened to about 6 percent of GDP in 1995. After elections were held in December 1995, the new Government prepared in early 1996 a bold fiscal consolidation program for 1996–97, with two thirds of the adjustment on the expenditure side. The program is aimed at reaching the Maastricht deficit criterion of 3 percent of GDP in 1997. In April 1996, Parliament approved the Government’s two-year budget, including the measures required to implement the Government’s fiscal consolidation program.

Finland

When Directors met in early September 1995 to conclude Finland’s Article IV consultation, economic developments in that country appeared to be marked by robust growth. Domestic demand was recovering, inflation remained low, and the external current account was in surplus. Nevertheless, unemployment remained high, and capacity constraints were evident in some export industries.

After falling a cumulative 13 percent over the previous three years, real GDP expanded by 4 percent in 1994 and continued its strong growth in early 1995. (See Table 14.) The rate of unemployment fell from a high of 19 percent in early 1994 to 17 percent in April 1995. Subsequent to its being floated in September 1992, the markka depreciated sharply. This devaluation, along with improved productivity, laid the basis for vigorous export-led recovery, in which export volumes rose by 10 percent for three consecutive years. During 1994, the current account of the balance of payments went into surplus for the first time in 15 years. Signs of transition to a more balanced recovery subsequently became evident. Private investment is up and domestic demand has increased. Moreover, the increase in exports in 1994 was based not on depreciation of the currency (the markka had in fact appreciated by 25 percent since early 1993), but on recovery in partner countries, including the transition economies, and on improved terms of trade, as pulp and paper prices had rebounded. In 1995 inflation had remained subdued, although several factors pointed toward higher consumer price inflation in the period ahead. Despite some reduction in expenditure, the central government fiscal deficit widened slightly to 10.5 percent in 1994, and no improvement was envisaged in 1995. This has occurred, among other factors, because of an increase in employee benefits, the cost of accession to the European Union, and the failure of fiscal measures to effect sufficient structural change.

Table 14FINLAND: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in September 1995; annual percent change unless otherwise noted)
1992199319941995
Domestic economy
Real GDP–3.6–1.63.95.0
Unemployment rate (in percent)13.117.918.416.5
Consumer price index2.62.21.11.5
External economy
Exports, f.o.b. (in billions of markkaa)105.8132.6152.2174.3
Imports, c.i.f. (in billions of markkaa)93.2101.6118.6133.5
Current account balance
(in percent of GDP)–4.6–1.01.12.5
Direct investment, net (in billions of markkaa)5.2–4.6–12.0
Portfolio investment, net (in billions of markkaa)34.835.137.4
Capital and financial account balance
(in billions of markkaa)13.90.923.5
External debt, net (in percent of GDP)48.255.150.2
Real effective exchange rates–17.5–15.96.34.51
Net international reserves (in billions of U.S. dollars)5.35.510.711.11
Financial variables
General government balance
(in percent of GDP)–5.9–7.8–5.6–4.7
Gross national saving
(in percent of GDP)12.113.617.521.0
Gross fixed investment–16.9–18.64.115.1
Broad money–0.13.81.9–0.31
Interest rate (three-month money market)13.37.75.46.02

First quarter 1995.

June 1995.

First quarter 1995.

June 1995.

In their discussion, Directors noted that recent developments in Finland owed much to steady financial policies pursued over the past three years. They stressed, however, that sustaining the growth needed to reduce unemployment without reawakening inflation would require greater fiscal consolidation supported by wage restraint, labor market reform, and other structural change. They welcomed the tightening of eligibility requirements for unemployment insurance, but noted that further reforms were needed because the current generosity of benefits was seen as weakening the restraining influence of the unemployed on wage demands. Although they expressed concern at the continued large fiscal deficits, they welcomed the draft budget for 1996, which was fully consistent with the previously announced fiscal program. In their view, the budget envisaged a significant reduction in the deficit and focused appropriately on measures that would permanently lower expenditures. They observed that the credibility of the Government’s strategy had been bolstered by measures, such as the agreement on pension reform, that would yield significant saving over the long term.

Directors pointed to the low level of inflation and to the strength of the markka as tangible indicators of the success of monetary policy in the preceding year. They stressed that the inflation target should remain the focus of monetary policy and agreed that, with the Government committed to fiscal consolidation, wage behavior posed the greatest risk to the inflation outlook. Directors observed that substantial currency appreciation had taken place and that Finland had started building a track record of exchange stability. They felt that additional market-driven appreciation need not be resisted.

Directors welcomed indications that Finland was making convincing progress toward integration into the European Union, but they noted that the challenge of integration reinforced the importance of structural reform. They expressed the hope that, notwithstanding budgetary constraint, Finland should be able to restore its traditionally generous provision of official development assistance.

Since the time of the Article IV consultation, the economic environment changed significantly. Reflecting primarily external shocks (particularly the economic slowdown in Europe), GDP growth declined markedly in the second quarter of 1995, Moreover, the wage agreement concluded in late September involved moderate wage increases for both 1996 and 1997. Against this background, the Bank of Finland eased monetary policy significantly, reducing its tender rate by a total of 2.25 percentage points between October 1995 and March 1996.

Developing Countries

Over the course of the 1996 financial year, the Board held more than ninety Article IV consultations with developing countries. Many countries were commended for their impressive pursuit of economic reform—often with the financial support of the Fund, Their aggregate record of strong growth with low or declining inflation was seen as reflecting the pursuit of prudent policies coupled with determined structural reforms. Most, however, require some further macroeconomic and structural adjustment; Directors counseled perseverance in creating the sound macro-economic policy environment that is needed to sustain high-quality growth. Financial markets tended to react quickly to any faltering of countries’ adjustment and reform efforts, and were now holding countries to a higher standard. Board members observed.

The robust aggregate performance of the developing countries masked widely divergent experiences among individual countries. While some countries had registered successive years of brisk growth, a number of other countries remained mired in a vicious circle of low growth, high inflation, and intractable external indebtedness. Directors stressed the vital importance of laying a solid foundation for growth and fostering the development of a vigorous private sector. For many developing countries with youthful populations about to swell the size of their workforce, a dynamic private sector was viewed as offering a key to higher growth and expanded employment opportunities. Directors emphasized that in many countries there was still considerable scope to reduce the role of government in the economy, encourage growth in the private sector, and shift needed resources to public sector investments in human resource development and infrastructure. They also noted the crucial role that governments play in shaping and sustaining a policy environment conducive to high-quality growth.

The Board cited civil order as a key precondition for both reform and growth. Sound macroeconomic policies and a vibrant private sector were unlikely to take root in conditions of strife and uncertain security. Directors hoped that several countries would soon be able to restablish the conditions necessary for civil order and growth; they also commended a few countries that had recently emerged from conflicts and were, with the assistance of the Fund and others, attempting to rebuild their economies.

In most of their discussions with member countries, Directors stressed the importance of strengthening fiscal discipline. They frequently underscored the need to address public sector deficits to ensure that these did not produce inflationary pressures or stifle private sector development. They cautioned a number of countries about rising or persistently high public sector debt. More generally, they emphasized the role that strong fiscal policies play in achieving and consolidating macroeconomic stability, ensuring adequate revenues, promoting higher domestic saving (and lower government dissaving), and stimulating investment. To ensure the adequacy of revenues, they often recommended expansion of the tax base and, in some instances, implementation of sales or value-added taxes, as well as improved tax administration and efforts to combat fraud.

In many instances, however, revenue-enhancing measures needed to be complemented by firm expenditure restraint. In particular. Directors observed that restraint in the public sector wage bill, which figures as a key element in many developing country government expenditures, could free up resources for more productive public and private sector investment. In some instances, public sector wage restraint could also exert a useful demonstration effect on private sector wages—thus helping countries to maintain or enhance external competitiveness.

Directors underscored the need to make effective use of resources and eliminate unproductive expenditures. In this regard they counseled a number of countries to end general subsidies, reduce military expenditures, and better target social safety nets. Reduced spending on unproductive activities would allow countries to shift resources to needed investments in human and physical capital, notably in health, education, and physical infrastructure. In addition to identifying unproductive expenditures, some countries would need to take broad and basic steps to rationalize and prioritize expenditures and to improve budgetary management. In many of their discussions, Directors urged countries to complement expenditure restraint with accelerated privatization and public enterprise reform.

On the monetary side, Directors commended a number of countries for pursuing appropriate monetary policies that had produced low inflation and a stable macroeconomic environment. They urged continued diligence where progress had been made and greater effort, in the context of comprehensive reforms, to stabilize the economy and bring down inflation where high rates continued to undermine growth prospects. Directors noted that wage indexation in some countries posed a serious obstacle to efforts to subdue inflation.

Where a change in monetary policy was recommended, it was often a move to tighten the monetary stance in response to underlying changes in the economy. Directors considered, for instance, that tighter monetary policies were indicated in several countries that had enjoyed extended periods of strong growth but now were running at near capacity and were at risk of overheating. More broadly, Directors encouraged a number of countries to move toward a greater reliance on market-based instruments in their formulation of monetary policies and in the setting of interest rates. They also noted the crucial role that positive real interest rates played in encouraging investment and growth.

Independent central banks have made a demonstrable contribution to the design and implementation of effective monetary policies, and Directors recommended that a number of countries strengthen the autonomy of their central banks. Directors also noted the dangers inherent in the automatic access of governments or public enterprises to credit. They likewise expressed great concern over credit policies in several countries that mandated or directed credit allocation, noting that such policies introduced distortions into the economy. In some instances, Directors made note of the use of bank-by-bank credit allocation but considered this an appropriate intermediate step until more indirect monetary policy instruments could be developed.

In their review of policies in the aftermath of the Mexican crisis, Directors weighed the impact of large and possibly volatile inflows of short-term capital and considered the effects of using capital controls to forestall sudden reversals in these flows. They noted that large capital inflows can complicate the management of monetary and exchange rate policy and suggested that policies designed to attract longer-term capital flows might be one means of addressing the issue. They had a mixed response to the use of capital controls, with many convinced that capital controls could not substitute for sound policy fundamentals.

To complement strong fiscal policies and the pursuit of low inflation, Directors stressed the role that structural reforms have in creating a flexible and responsive economy and ensuring the efficient use of resources. In many countries. Board members found considerable scope for implementing or expanding privatization efforts. More specifically, they pointed to the widespread need for civil service reform, which could both enhance the quality and effectiveness of the public sector and free up increased resources for investment. Board members also cited the need to restructure public enterprises to improve efficiency or to privatize these functions.

For a number of smaller economies, and particularly for many small island economies, Directors recommended increased diversification to improve the capacity of these economies to cope with fluctuations in demand for individual products. More generally, they stressed the need to retain external competitiveness and noted the vital importance of linking wage increases to productivity gains. Several countries were commended for their investments in education and training, which would allow their workforces to shift from labor-intensive to more skill-intensive production.

In the financial sector, Directors noted the fragility of the banking sector in a number of countries and highlighted the serious problems that could arise for stabilization efforts or growth if insolvency were to undermine the health of the banking system. They urged greater attention to the maturity composition of loan portfolios and increased efforts to identify and address problem loans and problem banks, as well as improved prudential supervision and regulation.

On exchange rate policy, while Directors noted that existing exchange arrangements had served many countries well, they did observe that there was scope in some countries for greater flexibility. They also emphasized in some discussions the importance of developing a market-based exchange rate policy, noting that it could be useful in reducing the risk of destabilizing short-term capital inflows. Directors commended a large number of countries for their efforts to reduce exchange and trade restrictions. Where multiple exchange arrangements remained in place. Directors urged adoption of a market-determined, unified exchange rate.

Directors welcomed the decision of an increasing number of member countries to accept obligations under Article VIII of the Fund’s Articles of Agreement. In so doing, these countries agree to refrain from imposing restrictions on payments and transfers on current international transactions and from discriminatory and multiple currency arrangements without the approval of the Fund. Board members expressed the hope that additional member countries would accept Article VIII status in the coming year.

While a number of countries successfully maintained or restored balance of payments viability, Directors cautioned that in most countries there was little room for a relaxation of policies and that further adjustment would be needed over the medium term. They pointed to several instances in which countries had relaxed policies prematurely, with a consequent serious deterioration in their external position.

Board members noted with concern the constraints posed by high debt burdens in a number of countries. They applauded steps taken by several countries to restructure their debt and debt service under the Naples terms and urged other countries to take similar steps. Directors urged a number of countries to refrain from borrowing on nonconcessional terms, so as not to jeopardize their external position or deepen their debt burden. They also stressed to a number of countries the grave importance of dealing expeditiously with domestic and external arrears and of moving to normalize relations with external creditors and donors.

Finally, the Board noted the critical role played by timely and adequate data in formulating appropriate policies. Directors complimented several members on the high quality of their data but noted that many others needed to improve the coverage, timeliness, and transparency of their economic and financial statistics. They observed that, where needed, technical assistance was available from the Fund.

Argentina

After four years of rapid economic growth aided by large private capital inflows, there was an outflow of capital from Argentina in the aftermath of the Mexican crisis that, in turn, caused a sharp contraction in domestic demand and activity. In response, the authorities took strong measures to bolster public finances and provide support to the banking system within the constraints of the Convertibility Law. They added a temporary surcharge of 3 percentage points, increasing the value-added tax to 21 percent; cur wages for higher-paid public employees; and established two trust funds to facilitate the restructuring of private banks and the privatization of provincial banks. As a result, when the Board discussed in September 1995 the Article IV consultation with Argentina, its economy appeared to have stabilized: about half of the nearly $8 billion outflow of bank deposits between December 1994 and mid-May 1995 had returned; bank credit was beginning to recover; the country had regained access to international capital markets; and international reserves were being rebuilt.

The events in early 1995, however, triggered a sharp fall in consumption and investment—and, consequciirlv, in GDP—in the second quarter of 1995, and real GDP for the year was projected to show little growth (see Table 15). Moreover, despite the measures taken, the credit squeeze and decline in consumption were pointing to a major revenue shortfall in 1995, necessitating a revision in the program’s fiscal policy objectives. Also, unemployment rose from 12 percent in October 1994 to 18½ percent in May 1995, principally as a result of the jump in the labor force participation rate.

Table 15ARGENTINA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in September 1995; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP8.76.07.40.5
Unemployment rate7.09.611.518.62
Consumer price index (period average)24.910.64.13.6
External economy
Exports, f.o.b. (in billions of U.S. dollars)12.213.115.821.4
Imports, c.i.f. (in billions of U.S. dollars)14.916.821.619.9
Current account balance
(in percent of GDP)3–2.8–2.9–3.5–1.3
Direct investment471.350.9–70.294.7
Capital account balance
(in percent of GDP)4.53.83.60.3
External debt–3.82.88.1
Debt-service ratio (in percent of exports of goods and nonfactor services)40.847.138.142.5
Real effective exchange rate13.89.8–1.3
Net international reserves (in billions of U.S. dollars)8.611.511.412.75
Financial variables
Overall public sector balance
(in percent of GDP, excluding privatization receipts)–0.20.9–0.5–0.8
Gross national saving
(in percent of GDP)13.915.316.417.5
Gross domestic investment
(in percent of GDP)16.718.219.918.8
Broad money (M3, period average)69.440.914.1
Interest rate (interfirm, period average)18.28.08.5

Projected.

As of May 1995.

The authorities estimate that the current account deficit in 1994–95 was narrower by about 0.3/0.5 percent of GDP on account of larger estimated interest receipts.

Including privatization.

As of September 1995.

Projected.

As of May 1995.

The authorities estimate that the current account deficit in 1994–95 was narrower by about 0.3/0.5 percent of GDP on account of larger estimated interest receipts.

Including privatization.

As of September 1995.

The sharp outflow of deposits and the growth in nonperforming loans was attenuated by bank capital in excess of the Basle accord on bank capital adequacy and the relatively high average legal reserve requirements. This allowed the Central Bank to maintain its commitment to price stability while containing the budgetary impact of the sizable reduction in the number of private banks, from 172 in December 1994 to some 125 in August 1995. The trust funds provided support to 14 private banks. In addition, 15 provincial banks were either privatized or in the process of privatization. To strengthen the banking system’s liquidity position and promote lower interest spreads, the Government announced that a uniform liquidity requirement would replace minimum reserve requirements by November 1995.

The real effective exchange rate of the Argentine peso depreciated by 8 percent between the beginning of 1994 and August 1995, and Argentina’s exports (in U.S. dollar terms) rose by 47 percent in the first half of 1995 over the corresponding period in 1994, boosted by the continued strong performance of manufactured goods exports. Meanwhile, the trade surplus for 1995 was projected to reach $1.4 billion, compared with a deficit of almost $6 billion in 1994, and the current account deficit for the year was expected to narrow to $3.7 billion from the $10 billion recorded a year earlier. The authorities estimated that the current account deficit in 1994–95 was about $1.0–1.5 billion narrower, on account of larger estimated interest receipts.

In their review, Directors commended the authorities for the decisive actions taken early in 1995 to stabilize the economy; they noted that, in response to those measures, confidence was recovering and deposits were returning to the banking system. They also took note of the significant strengthening in the external current account. However, economic activity had slowed more sharply than envisaged because of the credit squeeze, and unemployment increased sharply.

Against that background, Directors considered that the easing of the 1995 fiscal targets was warranted. At the same time, because the credibility and sustainability of the Convertibility Plan (which maintained parity between the Argentine peso and the U.S. dollar) required the maintenance of sound public finances. Directors underscored the critical importance of restoring fiscal equilibrium in 1996, including by combating tax evasion and further reducing expenditures. They also urged the authorities to deepen the process of reforming the provinces’ public finances.

Directors believed that the new uniform liquidity requirements should help to narrow interest rate spreads and strengthen the financial system. They welcomed the recovery of bank deposits after May 1995 but expressed concern about the continued weak condition of parts of the financial system. It was also emphasized that further structural reforms, especially those aimed at increasing labor market flexibility, strengthening competitiveness, and addressing the unemployment problem, would help to speed the Argentine economy’s return to a path of investment, output, and employment growth. Directors noted that the recently announced phased reduction in employers’ social security contributions could help to correct a major disincentive to employment.

In light of Argentina’s strong export performance and the rapid adjustment in the external accounts, Directors viewed Argentina’s present level of competitiveness as broadly adequate. The Board generally considered that Argentina’s exchange rate framework had served the economy well. Finally, given Argentina’s recent experience. Directors also considered that it would be prudent to strengthen the Central Bank’s free reserves beyond the program targets to bolster the Convertibility Plan.

Botswana

Directors discussed the 1995 Article IV consultation report for Botswana in February 1996 against a background of encouraging signs of recovery from the economic downturn of the early 1990s. From an average 10 percent a year during the 1980s, real GDP growth in Botswana had slowed to an average 3 percent a year during 1991–95, mainly because of weakness in the diamond sector, which had resulted in the imposition of a sales quota on diamond exports. Botswana’s overall performance is dominated by developments in the diamond sector, which by 1990 accounted for about 30 percent of GDP, nearly 80 percent of exports, and 55 percent of central government revenue.

While the economic slowdown reduced growth in government revenues, a delayed response to contain the momentum of growth in government expenditure caused the fiscal balance to deteriorate from a surplus of 10 percent of GDP in 1991–94 to a surplus of below 2 percent in 1994–95 (see Table 16). The budget for 1995/96, which provided for reduced income tax rates and continued public wage restraint, was expected to result in a modest deficit. Since 1993 a tight monetary policy has moderated growth in money and credit, helping to bring inflation down, and has contributed to positive real interest rates.

Table 16BOTSWANA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in February 1996; annual percent change unless otherwise noted)
199219931994119952
Domestic economy
Real GDP3–0.34.12.17.7
Consumer price index (annual average)16.114.410.610.7
External economy
Exports. f.o.b. (in millions of U.S. dollars)1,725.21,725.11,879.52,030.4
Imports, c.i.f. (in millions of U.S. dollars)1,539.51,457.91,508.71,627.0
Current account balance (in percent of GDP)6.112.51.36.5
Direct investment, including retained losses (in millions of U.S. dollars)–3.3–288.3–49.234.4
Portfolio investment (in millions of U.S. dollars)0.10.2–0.1–0.3
Capital and financial account balance
(in millions of U.S. dollar)6.68.56.06.9
External debt (in percent of GDP)15.816.716.718.3
Debt-service ratio (in percent of exports of goods and services)5.14.74.53.9
Real effective exchange rate1.23.7–0.90.6
Gross international reserves (in millions of U.S. dollars)3,7934,0974,4024,436
Financial variables
Central government balance (in percent of GDP)10.68.91.7–1.7
Broad money (M2)14.39.34.510.1
Interest rate (prime lending)14.515.014.514.5

Preliminary.

Estimated.

National accounts year beginning in July.

Preliminary.

Estimated.

National accounts year beginning in July.

In 1994, the value of merchandise exports increased by 9 percent in U.S. dollar terms, including a strong performance of textiles and vehicles, but import growth was limited to 3.5 percent because the economic slowdown reduced demand. The current account surplus dropped to 1.3 percent of GDP primarily because of lower earnings on international reserves, which by the end of 1994 had accumulated to the equivalent of 28 months of imports of goods and services. The nominal effective exchange rate of the pula depreciated by a cumulative 12 percent during 1991–95, reflecting the depreciation of the South African rand in relation to the U.S. dollar. Because inflation had been slightly higher in Botswana than in South Africa, reflecting in part the broadening of the sales tax, however, the real effective exchange rate appreciated by 4 percent in that same period.

Directors noted in their discussion that the authorities were continuing to pursue policies favoring a liberal economic system and that the economic recovery, although broadly based, was projected to moderate in the medium term because of uncertainties in the diamond market. They urged the authorities to strengthen financial policies further, to reduce inflation, and to deepen structural reforms. They pointed to a need to reduce dependence on mineral revenue and to broaden the tax base. Directors urged the authorities to phase out civil service loan guarantees and to secure appropriate funding for the civil service pension plan. They welcomed measures to strengthen cost recovery for public services, as well as recent reforms of public enterprises. They encouraged the authorities to expedite completion of the staffing of the Public Enterprise Monitoring Unit to coordinate reforms in the parastatal sector. Directors advised further sales of central bank instruments to absorb excess liquidity. Greater coordination of fiscal and monetary policies would be essential, particularly as further reforms would increase the potential for capital inflows.

In the external sector, Directors welcomed the ongoing tariff reforms under the South African Customs Union and the measures adopted by the authorities to reduce taxes and contain wages and other costs so as to strengthen external competitiveness. They considered that the present exchange rate system served Botswana well and that it should continue to be supported by sound financial policies. Directors welcomed Botswana’s acceptance of the obligations of Article VIII effective November 17, 1995 and expressed their appreciation for Botswana’s contribution to the ESAF Subsidy Account.

Directors observed that Botswana was undertaking important structural reforms to encourage private investment. They urged the elimination of bureaucratic impediments to higher private investment.

China

Directors met in April 1996 to conclude the Article IV consultation with China. The discussion was held against the background of the economy’s cooling down after prolonged overheating, without sharp deceleration in growth.

The Chinese economy entered a boom in early 1992. Domestic demand—especially investment—surged, fueled by expansionary financial policies, which contributed to an acceleration in inflation and in disorderly financial and exchange market conditions. Since mid-1993, economic policy has focused on cooling down the economy. Macroeconomic policies were tightened to reduce inflationary pressures and slow the growth of output and demand to a more sustainable pace. Despite some initial success, rapid monetary expansion and the effects of administered price increases and supply problems contributed to a resurgence of inflation in 1994. In 1995 the Government tightened financial policies, intensified controls on investment spending, and stepped up administrative measures to dampen inflation. Structural measures related to central banking, fiscal reform, the exchange system, and the legal framework were also implemented.

As a result, the overall inflation rate fell from its peak of 25 percent in October 1994 to about 8 percent by the end of 1995, and real GDP growth moderated from 12 percent in 1994 to about 10 percent in 1995 (see Table 17). The external sector remained strong: the current account was in surplus, large inflows of foreign direct investment continued, and international reserves rose from $54 billion in 1994 to about S77 billion at the end of 1995. These trends continued in early 1996.

Table 17CHINA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in April 1996; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP14.213.512.610.2
Urban employment2.42.15.40.3
Retail prices (end of period)6.717.623.38.3
External economy
Exports (in billions of U.S. dollars)69.675.7102.6128.1
Imports (in billions of U.S. dollars)64.486.395.3110.1
Current account balance
(in percent of GDP)11.5–2.81.50.2
Direct investment inflows
(in billions of U.S. dollars)12.027.533.837.7
Capital account balance (in billions of U.S. dollars; excluding errors and omissions)1–0.223.532.638.7
External debt (in billions of U.S. dollars)69.384.495.0106.6
Debt-service ratio (in percent of exports of goods and nonfactor services)9.810.29.37.32
Real effective exchange rate373.672.178.683.0
State gross international reserves
(in billions of U.S. dollars)421.223.053.576.0
Financial variables
Overall budgetary balance
(in percent of GDP)–2.3–2.0–1.6–1.7
Gross national saving
(in percent of GDP)137.740.541.439.7
Gross domestic investment
(in percent of GDP) 136.243.339.939.5
Broad money (end of period)31.324.034.529.9
Interest rate57.5610.9810.9810.98

Estimated.

Official estimate.

End of year, 1990 = 100; decline indicates a depreciation.

Since September 1992, the authorities have reported official reserves to include only the foreign assets of the People’s Bank of China and not those held by the Bank of China and other specialized banks.

Interest rate on one-year time deposits at end of year.

Estimated.

Official estimate.

End of year, 1990 = 100; decline indicates a depreciation.

Since September 1992, the authorities have reported official reserves to include only the foreign assets of the People’s Bank of China and not those held by the Bank of China and other specialized banks.

Interest rate on one-year time deposits at end of year.

In their discussion. Directors welcomed China’s continued impressive economic performance and the moves toward a market-based system, to strengthen macroeconomic management, and to further integrate the country into the global economy. They commended the successful moderation of growth and demand toward more sustainable rates and the reduction of inflation to single digits. Directors urged the authorities to press ahead with cautious financial policies and bold structural reforms.

A cautious approach to financial policies, Directors stressed, was essential given the risk of renewed inflationary pressures. Moreover, deep-seated weaknesses in the state-owned enterprise and financial sectors needed urgent attention so as not to compromise the appropriate stance of financial policies. Directors also emphasized that, while sustaining low inflation would require a significant slowing of broad money growth, policy implementation would need to be flexible in view of risks and uncertainties.

Directors were concerned at the decline in the ratio of fiscal revenue to GDP, which had necessitated a compression in budgetary expenditure. Continued revenue weaknesses would preclude social spending to support enterprise restructuring and infrastructure. Directors welcomed measures to scale back and rationalize preferential tax policies. They emphasized that further actions to broaden the tax base and strengthen tax administration were needed to boost revenue and achieve the authorities’ medium-term goal of eliminating the budget deficit while meeting prospective expenditure needs. Directors stressed that budgetary saving could be enhanced by rationalizing expenditures and further improving budgetary management and control.

Directors underscored that China’s strong external position offered scope for accelerating trade and payments liberalization, and they welcomed the initiatives taken in those areas. Directors attached particular importance to reducing quantitative restrictions and liberalizing foreign trading rights. They welcomed the Government’s experiments in liberalizing exchange controls in selected pilot zones and issuing an interim foreign exchange control regulation to provide a transitional framework for further exchange liberalization. Most Directors urged the early removal of the remaining restrictions on current international transactions and hoped that China would soon accept the obligations of Article VIII of the Fund’s Articles. In addition. Directors emphasized that upward pressure on the exchange rate would be alleviated by early and substantial trade reform.

Directors endorsed the priority accorded to the problems of state-owned enterprises. They welcomed experimental initiatives, such as increased scope for diverse forms of ownership, and called for bolder reforms, including establishment of a clearer legal framework. Directors remarked that successful and sustainable state-owned enterprise reform would require intensified efforts to establish a social safety net and to encourage labor mobility while promoting jobs in the nonstate sector. Directors urged the Government to build on nascent efforts to reduce subsidized credit and other financial support to state-owned enterprises.

Directors welcomed monetary and financial sector reforms, including open market operations in an integrated interbank market. They strongly supported plans to develop the infrastructure for indirect monetary management and to strengthen prudential regulation. Directors called for action to address the non-performing loans of the specialized banks. They welcomed the greater flexibility in selected short-term interest rates but emphasized the need to further simplify the rate structure and to adjust administered rates more frequently. Directors expressed concern about weaknesses in China’s economic statistics but acknowledged China’s efforts to address them, and they urged strong further actions.

Colombia

Directors discussed Colombia’s 1995 Article IV consultation in January 1996. Against the background of the steady real GDP growth over the previous 25 years and the leveling off of inflation at 23 percent in 1994, the authorities’ objectives in 1995 were to maintain output growth at 5.5–6.0 percent, reduce inflation to 18 percent, and increase international reserves moderately. To achieve these objectives, they set a target of fiscal balance or small surplus and planned the continuation of the firmer monetary policy adopted in the second half of 1994.

In the event, although output growth declined slightly in 1995, partly because of a slowdown in private consumption and investment in response to a monetary tightening in late 1994, it still remained above 5 percent (see Table 18). Output was stimulated by an increase in investment of 14, 8 percent. The inflation rate decreased for the fifth successive year to 19, 5 percent—the first time in ten years it had dropped below the level of 20 percent. Despite the postponement of some large import-intensive projects in the oil sector, the current account deficit widened to 5¼ percent of GDP in 1995 from 4½ percent in 1994. Net international reserves increased about as projected in 1995, and gross reserves ended the year at $8.5 billion, equivalent to some five months of imports of goods and services. The trade deficit narrowed to 3.2 percent of GDP in 1995 from 3.5 percent in 1994, as nontraditional exports grew by 20 percent in U.S. dollar terms.

Table 18COLOMBIA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in January 1996; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP4.05.25.75.3
Unemployment rate10.28.68.98.4
Consumer price index (period average)27.022.422.820.9
External economy
Exports, f.o.b. (in millions of U.S. dollars)7,2637,4288,75610,725
Imports, f.o.b. (in millions of U.S. dollars)6,0299,08611,04013,249
Current account balance
(in percent of GDP)1.8–3.9–4.6–5.3
Direct investment56.94.6113.538.5
Portfolio investment (in millions of U.S. dollars)65.0203.0–65.0200.0
Capital account balance
(in percent of GDP)0.94.14.75.5
External debt35.034.832.828.9
Debt-service ratio (in percent of exports of goods and services)44.937.239.635.3
Real effective exchange rate
(end of period)8.67.310.5–7.82
Net international reserves (in millions of U.S. dollars)1,326153128185
Financial variables
Nonfinancial public sector balance
(in percent of GDP)–0.1–0.20.5–0.7
Gross national saving
(in percent of GDP)19.016.015.315.3
Gross domestic investment
(in percent of GDP)17.219.919.820.6
Broad money35.030.236.229.4
Interest rates
90-day deposit rate26.425.629.532.03
Lending rate37.335.840.543.14

Estimated.

Percent change from December 1994 to October 1995.

January-December 14, 1995.

January-November 1995.

Estimated.

Percent change from December 1994 to October 1995.

January-December 14, 1995.

January-November 1995.

The combined public sector deficit of 0.5 percent of GDP, although still within relatively conservative bounds, was higher than programmed owing to a shortfall in income tax collections, continued growth in public spending, and the lower-than-expected world market prices for coffee, which led to an unexpected deterioration in the finances of the National Coffee Fund.

In their discussion, Directors observed that the favorable performance and the ability of the Colombian economy to weather the shocks in the regional economy testified to the authorities’ sound, consistent economic management. While welcoming the reduction of inflation by December 1995 to below 20 percent for the first time in many years, Directors emphasized that inflation was still excessive and that the further reduction of inflation remained the key policy challenge. They encouraged the authorities to implement a stronger, more balanced mix of financial policies than was currently envisaged to accelerate the reduction. In particular, Directors considered that a tighter fiscal stance was needed to relieve the burden on monetary policy and improve the outlook for private sector activity. To break entrenched inflation expectations, they called for further progress in eliminating backward-looking wage settlements. At the same time, the importance of protecting social expenditures was noted. Directors called for the curtailment of nonessential current outlays and a slower, more selective increase in capital expenditure, and they welcomed the December 1995 measures to increase tax rates, improve tax administration, and reduce evasion. They also welcomed the efforts to tighten monetary and credit conditions and urged the authorities to persevere with monetary discipline to reduce inflation further.

Directors observed that the implementation of sound financial policies was also the key to the credibility of the managed exchange rate band, which had shown resilience in the face of adverse regional and domestic developments in 1995. Some Directors noted that a phased relaxation of the restrictions on external borrowing might be in order, provided that it was accompanied by a strengthening of fiscal and other policies designed to increase domestic saving. Some Directors expressed concern at the deterioration in the current account deficit. While this had been financed mainly by foreign direct investment, they considered that tighter financial policies and efforts to raise domestic saving were called for to reduce risks and to ensure sustained and balanced growth.

Côte d’Ivoire

Directors met in December 1995 to discuss the Article IV consultation with Côte d’I voire and to review the second annual ESAF arrangement (see the section on Fund Support of Member Countries). The discussion took place against a background of positive developments in the Ivoiricn economy.

The devaluation of the CFA franc in January 1994, stronger macroeconomic policies, and structural reforms had placed Côte d’Ivoire back on a path of sustainable growth. GDP grew by 1.8 percent in 1994 and was projected to grow by 6.5 percent in 1995 (see Table 19), After the adjustment in tradable goods prices following the devaluation, by mid-1994 inflation had been brought under control through tighter fiscal and wage policies and temporary price controls. However, largely because of food price increases in the first half of 1995, 12-month inflation was projected at 9 percent.

Table 19CôTE D’IVOIRE: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in December 1995; annual percent change unless otherwise noted)
199311994119952
Domestic economy
GDP (at constant prices)0.11.86.5
Consumer price index (end of period)2.632.29.0
External economy
Exports, f.o.b. (at current prices, CFAF basis)–3.7114.123.6
Imports, f.o.b. (at current prices, CFAF basis)–5.987.232.2
Current account balance (in percent of GDP)3–10.8–2.3–2.3
Capital account balance (in millions of U.S. dollars)47.1656.9138.5
External debt (in percent of GDP) 4158.9200.1175.3
Debt service (in percent of GDP)516.918.817.3
Real effective exchange rate6–2.4–38.69.5
Net foreign assets7–10.767.022.4
Financial variables
Consolidated government balance (in percent of GDP, payment-order basis)–13.3–7.6–4.5
Gross national saving (in percent of GDP)–2.212.413.7
Gross national investment (in percent of GDP)8.614.816.0
Money and quasi-money (M2)–4.446.919.5
Interest rates (average, end of period)
Money market rate7.55.56.0
BCEAO discount rate10.510.07.5

Estimated.

Projected.

Including official transfers but excluding late interest on payments arrears to commercial banks.

Including obligations to the Fund, short-term liabilities to the Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO) operations account, and all arrears to commercial banks.

Including obligations to the Fund but excluding late interest on payments arrears to commercial banks.

Based on end-of-period changes in relative consumer prices and nominal effective exchange rate; indicates a depreciation.

End of period (percent change in beginning-of-period broad money); for 1993, adjusted on the basis of the CFAF devaluation in January 1994.

Estimated.

Projected.

Including official transfers but excluding late interest on payments arrears to commercial banks.

Including obligations to the Fund, short-term liabilities to the Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO) operations account, and all arrears to commercial banks.

Including obligations to the Fund but excluding late interest on payments arrears to commercial banks.

Based on end-of-period changes in relative consumer prices and nominal effective exchange rate; indicates a depreciation.

End of period (percent change in beginning-of-period broad money); for 1993, adjusted on the basis of the CFAF devaluation in January 1994.

The external current account deficit was reduced by about 75 percent in 1994, to 2.3 percent of GDP, and was expected to stabilize at that level during 1995. The overall fiscal deficit, owing to strong government revenue performance and expenditure policies, was reduced to 7.6 percent of GDP in 1994; additional tightening in 1995 was projected to narrow the deficit to 4.5 percent of GDP. The Government had accelerated structural reforms in 1995, taking steps to liberalize further the internal market, as well as domestic and external marketing of cocoa and coffee; to remove nontariff barriers on imports; to increase labor marker flexibility; and to quicken the pace of privatization.

In their discussion, Directors noted that the Ivoirien economy had responded remarkably well to the shift in relative prices and the improved competitiveness made possible by devaluation of the CPA franc. Restrictive macroeconomic policies and structural reforms, they noted, had contributed to sizable reductions in fiscal and external imbalances and to progressive alleviation of structural rigidities, with the result that growth had resumed and saving and investment had increased. Directors observed that, although inflation had been rapidly controlled after the devaluation, there had been some residual pass-through effects during the first half of 1995. They welcomed the authorities’ intention to further strengthen macro-economic policies so that domestic demand and prices would be kept in check and competitiveness would not erode.

Directors considered that fiscal sustainability was the key to external sustainability, and they noted with regret the overruns in some expenditure categories, relative to program benchmarks, and the delays in privatization. They urged the Government to maximize the opportunity presented by favorable conditions—by consolidating the fiscal position in 1996 and accelerating structural reforms—so that the conditions for medium-term growth would be strengthened.

In the fiscal area, Directors stressed that it was important to achieve the programmed reduction in the fiscal deficit. They noted that broadening the tax base and improving tax administration had become more urgent because of tax cuts and the lowering of duties and levies on cocoa and coffee exports. Directors also stressed the need for greater control over spending commitments and for prioritizing expenditures. In this regard, they placed great importance on the Government’s efforts to improve budgetary procedures and unify the budget. In the structural area, Directors welcomed labor market and price deregulations and liberalization of maritime transportation and cocoa and coffee marketing. In their view, however, attracting new private investment would require a critical mass of additional structural reforms, including restructuring and privatization of public enterprises, reducing the cost of economic and administrative regulations, establishing more efficient administrative regulations, and improving the judicial system.

Directors were concerned about the accumulation of nonreschedulable external arrears in September-October 1995 and urged the authorities to settle those arrears promptly. Although Côte d’Ivoire’s fiscal and external positions had improved, the external debt burden remained heavy, and sizable residual financing gaps would remain. Consequently, Directors recognized that, for the country to attain financial viability, there would be a need for continued external financial assistance on concessional terms and for debt relief.

Directors urged the regional monetary authorities to develop new market-based instruments that could be used to regulate banks’ lending capacity and mop up excess liquidity. They emphasized the need to deepen and modernize financial intermediation in a number of areas, ranging from the creation of improved rural credit facilities to developing the stock market, so that the mobilization of saving and the financing of investment might be improved.

India

Directors met in July 1995 to conclude India’s Article IV consultation. The discussion took place against the background of a robust economic expansion and solid external position. Recovery had become well entrenched—real GDP growth was estimated at about 6 percent in 1994/95 (see Table 20)—reserves had risen to a comfortable level, the current account deficit was modest, exports were growing rapidly, and the exchange rate was broadly competitive.

Table 20INDIA: SELECTED ECONOMIC INDICATORS

(Data as of Board discussion in July 1995; annual percent change unless otherwise noted)1

1992/931993/941994/9521995/963
Domestic economy
Real GDP4.34.36.346.24
Wholesale prices (end of period)7.010.811.08.0
External economy (in billions of U.S. dollars unless otherwise noted)
Exports, f.o.b.18.922.726.730.7
Imports, c.i.f.23.224.029.535.0
Current account balance–3.9–0.6–1.4–4.0
Direct investment0.30.61.01.5
Portfolio investment0.23.53.51.1
Capital and financial account balance2.88.57.84.8
External debt (in percent of GDP, end of period)536.935.831.227.9
Debt-service ratio (in percent)30.425.427.327.1
Real effective exchange rate
(annual percent change, end of period)–3.23.8–5.1
Gross official reserves (end of period)6.415.120.820.1
Financial variables
Consolidated public sector deficit
(in percent of GDP)68.411.010.59.9
Gross national saving
(in percent of GDP)20.020.221.422.5
Gross national investment
(in percent of GDP)22.020.421.923.6
Broad money (end of period)15.718.421.215.5
Interest rates711.110.111.2

Fiscal years (April 1 through March 31).

Estimated.

Projected.

Data revised subsequent to the Board discussion.

Including military debt.

For 1995/96, projection based on 1995/96 budget proposals.

Rate on 364-day treasury bills, end of period.

Fiscal years (April 1 through March 31).

Estimated.

Projected.

Data revised subsequent to the Board discussion.

Including military debt.

For 1995/96, projection based on 1995/96 budget proposals.

Rate on 364-day treasury bills, end of period.

Nonetheless, inflation had been in the double digits for much of 1994/95, reflecting strong domestic demand and easier monetary conditions associated with heavy capital inflows. In response to these conditions, the authorities had taken measures to curb monetary growth, moderate capital inflows, and address supply bottlenecks. Against this background, inflation had recently declined to less than 10 percent, while interest rates had risen. Insufficient progress in fiscal adjustment complicated management of this situation. There had been some adjustment at the central government level in 1994/95, but the states’ finances had deteriorated. Consequently, the consolidated public sector deficit was estimated at about 10½ percent of GDP, close to its 1990/91 level.

Structural reforms had continued to progress in some areas over the preceding year, but the process was slow, and further efforts would be needed before the full benefits fed through. In a number of areas—such as public enterprise reform and agricultural policy—reforms had lagged well behind.

In their discussion, Directors commended India’s robust economic recovery and external strengthening, which were the result of the reforms initiated in 1991. Fiscal consolidation was seen as critically important to sustaining this progress. Directors pointed to inflationary pressures and rising interest rates as evidence of emerging strains and also expressed concern about the high level of public debt. Because of the urgency of fiscal consolidation, they could not subscribe to a strategy of more gradual adjustment and stressed that, at a minimum, any slippage from budget targets for 1995/96 should be avoided. They also emphasized the importance of hardening budget constraints on the states to encourage them to progress with reforms of state finances and to share the burden of fiscal adjustment.

In the absence of major fiscal consolidation, Directors observed, a heavy burden was being placed on monetary policy. They welcomed the progress in slowing inflation and endorsed the authorities’ inflation target of 8 percent by the end of 1995/96. Attaining this goal would require a sustained reduction in monetary growth. To signal anti-inflationary commitment, the authorities would need to adhere to agreed limits on automatic government access to Reserve Bank of India credit in 1995/96 and to phase out such borrowing as soon as possible.

Provided that fiscal consolidation was sustained and reform continued, Directors considered that the prospects for India’s external position remained sound. They endorsed India’s cautious approach to managing capital inflows and encouraged a greater role for foreign direct investment. Many Directors also encouraged more vigorous import liberalization. While noting that the level of the exchange rate was broadly appropriate, Directors supported greater flexibility in exchange rate policy. They urged maintaining the momentum of structural reforms in the current year, including accelerating planned tax and trade reforms, and removing the remaining obstacles to private participation in infrastructure investment.

Looking beyond the immediate policy situation, Directors emphasized that achieving rapid growth, price stability, and sustained poverty reduction would require a vigorous promotion of the private sector, including participation of foreign investors. The Government would be required to sustain fiscal adjustment and embark on a bold second wave of reforms to further raise saving and investment. Fiscal consolidation should be based on raising revenue by broadening the tax base, improving cost recovery, and pruning low-priority spending. Additional structural reforms were needed in areas that so far had received less attention, including restructuring and privatization of public enterprises, reform of the labor market and exit policies, import liberalization for consumer goods, agricultural sector reform, and liberalization of the financial sector. Directors welcomed India’s acceptance of the obligations under Article VIII of the Fund’s Articles, and they encouraged removal of remaining exchange restrictions.

Indonesia

In July 1995 Directors met to conclude the Article IV consultation with Indonesia. The country’s economic management had been impressive, although the authorities faced the challenge of a short-term overheating of the economy. Monetary policy had been eased in mid-1993 to support growth. Fixed investment picked up, private consumption rose considerably, and GDP growth reached about 7¼ percent in 1994 (see Table 21). Domestic demand expansion led the increase in activity and exceeded GDP growth in 1994/95. Although export growth increased, import growth rose more, and the external current account deficit widened slightly, to 2 percent of GDP. Monetary aggregates grew rapidly during 1994/95, with an expansion in domestic assets more than offsetting a decline in international reserves. This expansion occurred despite a gradual increase in interest rates since April 1994. Inflation remained high—in June 1995, the 12-month inflation rate was 10.5 percent.

Table 21INDONESIA: SELECTED ECONOMIC INDICATORS

(Data as of Board discussion in July 1995; annual percent change unless otherwise noted) 1

1992/931993/941994/9521995/963
Domestic economy
Real GDP (calendar year)6.56.57.37.5
Consumer price index (end of period)5.010.29.69.5
External economy (in billions of U.S. dollars unless otherwise noted)
Exports, f.o.b.35.336.542.0
Imports, c.i.f.30.332.337.7
Current account balance–2.9–3.0–3.6–5.3
Direct investment1.72.02.5
Portfolio investment1.22.00.8
Capital and financial account balance47.73.32.25.4
External debt83.589.197.6101.1
Debt-service ratio (in percent of exports of goods and nonfactor services)21.521.320.320.8
Real effective exchange rate
(annual percent change)–3.9–2.7–3.3
Gross official foreign assets18.318.617.117.3
Financial variables
General government balance
(in percent of GDP)–1.5–0.50.2–0.3
Gross national saving (calendar year; in percent of GDP)33.331.332.031.3
Gross national investment (calendar year; in percent of GDP)35.933.234.033.8
Broad money (end of period)22.221.221.518.9
Interest rates513.59.312.814.3

Fiscal years (April 1 through March 31) unless otherwise noted.

Estimated.

Projected.

Inclusive of monetary movements of commercial banks and errors and omissions.

Cutoff rates in auctions of 30-day central bank debt certificates in December of calendar year (for 1995, the rate is for March).

Fiscal years (April 1 through March 31) unless otherwise noted.

Estimated.

Projected.

Inclusive of monetary movements of commercial banks and errors and omissions.

Cutoff rates in auctions of 30-day central bank debt certificates in December of calendar year (for 1995, the rate is for March).

Fiscal policy, which had been tightened in mid-1993 when monetary conditions were cased, continued to have a dampening effect. Oil prices were slightly above budget assumptions, revenues and current expenditures were on target, and development expenditures were relatively slow. The overall central government position was in balance in 1994/95, with the deficit (excluding oil and gas revenue) falling to 3¼ percent of GDP. The external current account deficit was financed mainly by long-term capital inflows. Short-term capital flows, which had fluctuated widely in 1993/94, stabilized in early 1994/95.

In their discussion, Directors warmly commended Indonesia’s policies, which had led to an impressive economic performance, reduced reliance on the oil sector, and improved living standards. Policies to achieve macroeconomic stability and high saving and investment rates, combined with market-based structural reforms, had provided the basis for continued confidence of both domestic and foreign investors. Directors particularly welcomed the Government’s recent trade reforms.

Directors noted that, given the high level of external debt and the need to contain the current account deficit, a significant fiscal adjustment would be required over the medium term, with the emphasis falling on revenues. Other medium-term challenges would include prioritizing expenditures, further liberalizing trade and investment, and promoting the private sector. Overheating of the economy in the short term was also of concern: already inflation had been higher than targeted, and the current account deficit had widened. A strategic decision to bring inflation down substantially was needed. To achieve that goal and to improve the sustainability of medium-term growth objectives, tighter fiscal and monetary policies combined with greater flexibility in exchange rate policy were required.

While recognizing the authorities’ impressive fiscal adjustment in the face of declining oil revenues, Directors stressed that additional fiscal adjustment would be essential to increase public saving over the medium term and to limit short-term demand pressures. Tax changes that had been introduced recently, they noted, would adversely affect revenues in the short run, and they encouraged additional measures during 1995/96 to increase revenue from sources other than oil and natural gas. Directors also pointed out the scope for further improving tax administration and widening the tax base. On the expenditure side, limiting spending to the budgeted amounts and resisting pressures for extrabudgetary financing were of priority.

Directors supported the gradual increase in interest rates since April 1994 and strongly recommended further tightening of monetary policy. If higher interest rates led to excessive capital inflows. Directors encouraged the authorities to allow market forces to play a greater role in exchange rate determination, including an effective appreciation of the rupiah. Directors welcomed efforts to widen the exchange rate band and urged further steps in that direction. With regard to the problem of nonperforming loans in the banking system, they stressed the need to accelerate the program to improve the quality of new loans, resolve existing problem loans and problem banks, and improve prudential supervision.

Directors welcomed the recently announced tariff reductions and called for further efforts to reduce nontariff barriers and to liberalize trade in key commodities. While commending Indonesia’s exemplary record of foreign debt service, Directors urged reestablishing prudential ceilings on both external commercial borrowings and export credit facilities contracted by the public sector and supported the use of privatization receipts to repay expensive external debt. They encouraged the authorities to improve statistics, including better monitoring of private capital flows and private external debt stocks, nonbudgetary public transactions, and public enterprise accounts.

Israel

In September 1995, Directors met to discuss the Article IV consultation with Israel, Over the previous five years, Israel’s economic policies had been influenced by a massive wave of immigration from the countries of the former Soviet Union. Since 1990, over 600, 000 immigrants had been absorbed into the domestic economy.

Real GDP expanded by 6.5 percent in 1994, and unemployment, which had peaked at 11.2 percent in 1992, fell to 6.9 percent in the first quarter of 1995 (see Table 22). Inflation accelerated to 14½ percent in 1994, from 11.2 percent in 1993, but declined to 9½ percent in the first half of 1995.

Table 22ISRAEL: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in September 1995; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP6.63.46.55.0
Unemployment rate (average)11.210.07.87.2
Consumer price index (average)11.910.912.310.2
External economy
Exports, f.o.b. (in billions of U.S. dollars)13.314.816.517.8
Imports, c.i.f. (in billions of U.S. dollars)–18.3–20.4–22.6–25.9
Current account balance (in billions of U.S. dollars)0.2–1.4–2.8
Capital account balance (in billions of U.S. dollars)–2.12.01.17.0
External public debt19.0221.020.0
Real effective exchange rate3–4.91.62.4
Net debt service415.415.716.6
Gross official reserves (end of period) 52.22.62.54.1
Financial variables
Gross national saving (in percent of national income)21.619.518.119.0
Gross domestic investment (in percent of national income)21.721.321.7
Nominal broad money (end of period)33.025.026.0

Fund staff estimates.

Average 1990–92.

Based on Fund staff estimates (using consumer prices); fourth quarter over fourth quarter.

As percentage of total exports of goods and services.

In months of total imports of goods and services.

Fund staff estimates.

Average 1990–92.

Based on Fund staff estimates (using consumer prices); fourth quarter over fourth quarter.

As percentage of total exports of goods and services.

In months of total imports of goods and services.

Private consumption rose by almost 9 percent in 1994, while nonresidential investment grew by an impressive 17 percent. The private saving rate, which had reached around 20 percent of GDP at the beginning of the 1990s, dropped to 16¼ percent of GDP. In the public finances, the overall deficit declined to 1 percent of GDP, from 2.8 percent in 1993, and the public debt fell from 99 percent of GDP in 1993 to 92 percent in 1994.

In July 1993, the Bank of Israel reduced the preannounced crawl of the exchange rate from an annual rate of 8 percent to 6 percent, consistent with the 8 percent inflation target set for 1994. Failure to meet the inflation target resulted in a real effective appreciation of the currency between mid-1993 and early 1995 of 6 percent. This, coupled with the strong growth in aggregate demand, led to a current account deficit of 4 percent of GDP in 1994 and about 6 percent in the first quarter of 1995.

To finance the deficit, Israel drew on its loan guarantee with the United States. With the private sector also borrowing heavily abroad to take advantage of lower interest on foreign currency loans, official net international reserves rose from $6.5 billion at the end of 1993 to a record S9.6 billion in May 1995.

Directors commended the Israeli authorities on the economy’s impressive growth since 1990 and for successfully absorbing the new immigrants, while reducing unemployment. They were also pleased that growth prospects had been enhanced by the peace process; however, the overheating of the economy was of concern. While not considering the external current account deficit an immediate financing problem. Directors agreed that its present level was not sustainable.

They saw strengthening domestic saving as the key policy challenge and emphasized that fiscal policy would need to play a crucial role in this regard. To that end, they recommended a more ambitious fiscal effort based on tight control over expenditures, Fiscal retrenchment was also needed to reduce public debt, meet future pension obligations, and prepare for any future reduction in unilateral transfers from abroad. In this connection, Directors praised efforts to reform the pension system but warned that without further action, the system would impose a heavy burden on future budgets.

Noting the disappointing price performance in 1994. Directors cautioned against a premature reduction in interest rates, stressing that monetary policy must be directed at meeting the Government’s inflation target in 1995 and at laying the basis for a further decline in inflation thereafter. Directors considered that the exchange rate band system had served Israel well. Nevertheless some Directors, noting that the conduct of monetary policy had been complicated by short-term capital inflows, warned that without further fiscal restraint, the authorities could face further exchange rate appreciation or larger capital inflows.

Aggregate demand policy, in the view of Directors, needed to be complemented by a reinvigorated supply-side approach. Regretting that the privatization process had slowed, they supported the Government’s recently proposed option distribution scheme and urged its early implementation.

Directors welcomed the opportunity to review recent economic developments in the West Bank and Gaza Strip and the fund’s increased involvement in providing technical assistance to the Palestinian Authority. They considered that the development strategy in that region should be outward oriented and led by the private sector and attached the highest importance to establishing sound and transparent public finances.

Korea

At the time of the conclusion of Korea’s Article IV consultation in October 1995, the growth forecast, which had been revised upward several times since the beginning of the year, pointed to an increase in real GDP of more than 9 percent in 1995 (see Table 23). The expansion, which had begun in 1993 and had gained momentum in 1994, was underpinned by the continued rapid rise in exports and equipment investment. As a result of the surge in growth, the emergence of a small positive output gap for 1995 seemed likely.

Table 23KOREA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in October 1995; annual percent change unless otherwise noted)
1992199319941995
Domestic economy
Real GDP5.15.88.49.0
Unemployment rate2.42.82.42.0
Consumer price index6.24.86.24.5
External economy
Exports, f.o.b. (in billions of U.S. dollars)75.280.993.7123.2
Imports, f.o.b. (in billions of U.S. dollars)77.379.196.8128.0
Current account balance
(in percent of GDP)–1.50.1–1.2–2.0
Direct investment (net, in millions of U.S. dollars)–496–540–1,318–1,703
Portfolio investment (net, in millions of U.S. dollars)5,74210,7256,8058,518
Overall balance (in billions of U.S. dollars)3.73.04.6
External debt (in percent of GDP)14.013.314.7
Debt-service ratio (in percent of exports of goods and nonfactor services)6.09.16.2
Real effective exchange rate1–0.7–0.90.44.3
Gross international reserves (in billions of U.S. dollars, end of period)17.120.225.632.7
Financial variables
Consolidated central government balance (in percent of GDP)–0.70.30.50.52
Gross national saving
(in percent of GDP)34.735.134.735.1
Gross domestic investment
(in percent of GDP)36.635.135.937.0
Broad money (M2)18.418.615.615.5
Interest rate (yield on corporate bonds, period average)16.212.612.913.8

Average for December over the same period of the previous year.

Preliminary estimate of outturn.

Average for December over the same period of the previous year.

Preliminary estimate of outturn.

Although producer price inflation had increased to almost 6 percent in June 1995 in response to pressures from prices of imported raw materials, consumer price inflation remained subdued and even fell slightly. Wage increases were moderate, following a boost in earnings in manufacturing in 1994 that had outpaced productivity gains.

Fueled by a continuing rise in imports, the current account deficit more than doubled in January May 1995 over the same period in 1994 but remained moderate in relation to the size of the economy. The balance of payments recorded a small surplus over this period while international reserves grew further, largely because of valuation effects associated with exchange rate movements. Against the background of the broadly balanced external payments position, the won depreciated by 2¼ percent in real effective terms during January–May 1995, primarily because of the sharp decline of the dollar against the yen, before strengthening in June–August.

With the momentum of growth expected to remain strong, the authorities in 1995 accelerated the move toward macroeconomic restraint begun earlier in the expansion. The 1995 consolidated central government budget implied a small withdrawal of stimulus, and the target range for M2 growth was lowered to 12–16 percent. However, monetary expansion in the first half of 1995 exceeded the upper limit of the target range.

In their discussion. Directors commended the authorities for Korea’s remarkable economic record, particularly the continued subdued inflation in the face of rapid growth. Nevertheless, they cautioned that. with the economy approaching full employment, there was a need for a cautious macroeconomic approach to avoid the dangers of overheating. In that connection, Directors felt that the withdrawal of fiscal stimulus in 1995 was appropriate, and they welcomed the authorities’ intention to expand investment in social overhead capital to ease infrastructure bottlenecks without weakening the overall fiscal position. The Board also welcomed the deceleration of the M2 growth rates in recent months. In addition, it considered that, as the demand for M2 had become less stable, the authorities should pay more attention to a broader range of indicators, including interest rates.

Directors welcomed the authorities’ commitment to steady implementation of the structural policy agenda, emphasizing that the Government should further deregulate and open the economy to complete Korea’s transformation into an advanced industrial country, fully integrated into the world economy. The present conditions were optimal to accelerate the needed structural reforms in the financial system, the capital account, and trade. Directors pointed to the importance for the financial reform program of developing a fully market-based system of monetary control; they also noted that most lending and deposit rates had been liberalized but remained more sticky than expected. Directors commended the Foreign Exchange Reform Plan announced late in 1994 to support the opening of the capital account but urged the authorities to develop a more specific timetable and accelerate the liberalization. Directors generally thought that, with the opening of the capital account, exchange rate flexibility was becoming increasingly important. Accordingly, they supported the case for more flexibility in the exchange rate and for greater use of the widened band in the market average rate system. They also considered that the recent strengthening of the real effective exchange rate had been in line with cyclical requirements and the improved external situation.

Mexico

Directors met in June 1995 to discuss the staff report for the 1995 Article IV consultation with Mexico and the second review under the stand-by arrangement that was approved in February 1995 for SDR 12.1 billion, of which SDR 6.8 billion was subject to augmentation and was later made available.

In early January 1995, the Mexican authorities adopted an economic program to deal with the financial crisis that followed the sharp depreciation of the peso in late December 1994. This program, which was supported by the stand-by arrangement, did not succeed in calming financial markets, and, in early March 1995, the authorities enacted additional measures, including greater fiscal adjustment and a lightening of monetary policy, which allowed an orderly reduction in 1995 of the external current account deficit to S654 million from the $14 billion projected initially.

The subsequent reaction of the markets was encouraging. The peso appreciated from about MexN$7.60 per U.S. dollar in early March to about MexN$6.20 per dollar in early June. During the same period, interest rates on one-month treasury bills fell from over 85 percent to 54 percent, and the stock marker recovered by about 32 percent. In this context, since the second quarter of 1995 Mexico was able to gradually return to the international capital markets. In response to the marked improvement in confidence, the Mexican Government resumed issues in May 1995 of 182-day treasury bills.

The need to amortize short-term external liabilities of the Government (mainly tesobonos) and the commercial banks in the first quarter of 1995 led to an increase in net domestic assets of the Bank of Mexico and a decline in net international reserves. However, the sharp rise in interest rates and the liquidity problems facing many banks resulted in a fall in credit to the private sector in real terms. An increase in net international reserves of $3.4 billion was observed in the second quarter of 1995, as the share of maturing tesobonos amortized in pesos rose and as commercial banks began to repay U.S. dollar-denominated loans that had been previously granted to them by the Bank of Mexico through Fobaproa (the Fund for Savings Protection). Meanwhile, the sharp decline of noninterest expenditure and a greater than envisaged collection of income taxes enabled the authorities almost to double the program target for the primary surplus of the nonfinancial public sector in the first quarter of 1995.

The trade surplus increased dramatically to a cumulative $1,3 billion in April 1995, compared with a deficit of $5.7 billion over the first four months of 1994. Real GDP in the first quarter of 1995 fell by 2.9 percent from the preceding quarter, but a slow recovery began in the third quarter of 1995. Real GDP contracted by 6.9 percent for the year as a whole (see Table 24). Inflation was expected to continue the decline observed in May 1995 until reaching 42 percent at the end of the year; in the event, worsening price pressures, originating from a larger-than-expected depreciation of the peso and adjustments to wages and public prices in December as part of the economic program for 1996, resulted in an end-year inflation rate of 52 percent.

Table 24MEXICO: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in June 1995; annual percent change unless otherwise noted)
19921993199419951,2
Domestic economy
Real GDP2.80.73.5–6.9
Open unemployment rate2.83.43.76.3
Consumer price index (end of period)11.98.07.152.0
External economy
Exports, f.o.b. (in billions of U.S. dollars)32.335.440.453.4
Imports, f.o.b. (in billions of U.S. dollars)48.248.958.946.3
Current account balance
(in percent of GDP)–7.4–6.5–7.8–0.3
Direct investment (in billions of U.S. dollars)4.44.411.07.0
Portfolio investment (bond placements and equity investments, in billions of U.S. dollars)8.317.06.40.9
Capital account balance
(in percent of GDP)8.08.43.0–0.2
Public sector external debt2,381.783.589.3116.8
External debt (in percent of exports of goods, services, and transfers)2254.1263.0249.3240.7
Real effective exchange rate
(average depreciation, -)7.57.4–4.0–33.3
Change in net international reserves
(in billions of U.S. dollars; increase, -)–1.9–7.117.91.3
Financial variables
Primary balance (in percent of GDP)5.83.92.35.6
Gross national saving
(in percent of GDP)14.114.213.914.7
Gross domestic investment
(in percent of GDP)21.520.621.715.0
Broad money (M2)229.417.622.834.7
Interest rate on one-month treasury bills
(average of primary auction)15.615.014.048.4

Preliminary.

Data revised subsequent to the Board discussion.

Includes debt to the Fund.

Preliminary.

Data revised subsequent to the Board discussion.

Includes debt to the Fund.

In their discussion, Directors noted the encouraging marked improvement in Mexico’s economic performance since March 1995. They considered that the current policy stance was appropriate, while they emphasized the need to maintain a tight monetary policy to reduce inflation further and stabilize financial markets. Continued strong macroeconomic policies and implementation of structural reforms should keep the external current account at a sustainable level while promoting an economic recovery.

Directors emphasized that the assurance of sufficient international funding would strengthen market confidence and contribute to the further accumulation of international reserves in the remainder of the year. In that context, they welcomed the decision by the United States to disburse $2.5 billion in July 1995 and its reiteration that additional funds would be available as needed in August 1995 to help amortize short-term external liabilities. They also agreed that the next two purchases from the Fund—through August—were essential as signals to markets of the continued official support for Mexico’s program and to support the reconstitution of external reserves, (Purchases were made in July and August 1995, respectively.) Directors generally believed that, with the continuation of appropriate policies, confidence should be sustained and normal access to international capital markets could be restored. While recognizing the important programs that have been put into effect, they welcomed the authorities’ intention to forgo purchases if the balance of payments and international reserves improved as projected under the program and to make early repurchases from the Fund as reserves permit.

Directors observed that the main monetary policy risks over the balance of the year would come from possible financial market pressures (if external financing were inadequate) and from a further deterioration in commercial banks’ loan portfolios. They emphasized that the restoration of the banking system’s health would depend mainly on the restoration of macroeconomic stability and a financial restructuring of the weaker banks. Directors commended Mexico on the recent improvement in the scope and quality of statistical information being made available for publication.

Mozambique

Directors met in June 1995 to discuss the Article IV consultation with Mozambique. In October 1992, Mozambique’s 16 years of strife came to an end with the signing of peace accords between the Government and the Renamo movement. Since then, 80, 000 troops have been demobilized, internationally supervised elections have been held, and resettlement of refugees and displaced persons has almost been completed. Removal of land mines and reconstruction are under way.

Since 1987, the Fund has assisted Mozambique with its adjustment efforts with financing from the structural adjustment facility (SAF) and the ESAF. Despite being one of the poorest countries in the world, Mozambique made considerable progress in reversing its economic decline, implementing structural reforms, and liberalizing its economy.

In 1994, Mozambique’s economic growth remained broadly based and strong at 5.4 percent (see Table 25). Production grew in every major sector except industry. where for the fifth year in a row it declined. Construction expanded at a real rate of 7.5 percent; transport and communications grew by 5.7 percent; and agricultural production increased by 5.0 percent, following a recovery of 21.3 percent in 1993.

Table 25MOZAMBIQUE: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in June 1995; annual percent change unless otherwise noted)
199219931994119952
Domestic economy
Real GDP–0.819.35.44.3
Consumer price index
(December 1989 = 100)54.543.670.124.0
External economy
Exports, f.o.b. (in millions of U.S. dollars)139.3131.8149.5170.0
Imports, c.i.f. (in millions of U.S. dollars)–855.0–954.7–1,018.5–868.7
Current account balance, including grants (in millions of U.S. dollars)–239.1–321.3–305.4–310.1
Direct investment, net25.332.035.045.0
Capital account balance (in millions of U.S. dollars)–155.1–107.0–22.125.7
External debt (in millions of U.S. dollars)5,083.04,999.05,403.95,610.0
Debt-service ratio (in percent of exports) Before debt relief144.5134.7119.2116.2
After debt relief388.382.869.782.1
Real effective exchange rate6.4–18.119.1
Gross reserves (in millions of U.S. dollars; end of year)4384.8372.1427.6475.2
Financial variables
Gross national saving (in percent of GDP)34.637.839.434.6
Gross national investment53.259.760.255.3
Money and quasi-money (M2)52.863.049.326.5
Interest rate (on 6- to 12-month deposits; end of period)43.043.069.7

Preliminary.

Program target.

The ratios exclude the effects of the debt cancellation granted by the Netherlands.

Gross foreign assets of the banking system.

Preliminary.

Program target.

The ratios exclude the effects of the debt cancellation granted by the Netherlands.

Gross foreign assets of the banking system.

In the wake of the 1994 elections, however, some economic indicators exceeded their targets under the Fund-supported economic and financial program for 1994, despite the authorities’ efforts to restrain them: inflation reached 70 percent in 1994 and broad money grew by 49 percent. A revenue shortfall and excess expenditure caused a widening in the Government’s overall budget deficit before grants to 30 percent of GDP—5 percent over target.

The balance of payments improved considerably in 1994. The current account deficit after grants amounted to $305 million, or 77 percent of exports of goods and services. Exports increased by 13 percent, or less than projected, partly owing to lower exports of cashew nuts. Imports rose by about 7 percent, a decline of 3 percent from the 1993 level, triggered by a fall in official transfers.

Since the exchange rate policy was further liberalized in mid-1994, with the elimination of the special exchange rate on tied aid funds, the market rate has been determined freely. The real effective exchange rate appreciated cumulatively by 19 percent from December 1993 to December 1994. Social issues continued to be a priority for public policy in 1994, particularly poverty alleviation.

In their discussion, Directors commended the Mozambican authorities for the smooth completion of the demobilization program and the resettlement of millions of displaced persons and refugees. They noted that with the restoration of peace, the new Government had a historic opportunity to reorient the country’s efforts toward achieving sound export-led and self-generating growth.

Directors expressed concern that the fiscal deficit and inflation had substantially exceeded the economic and financial program targets. They, therefore, urged the authorities to make every effort to carry out fully the 1995 program, in support of which Mozambique had requested an extension of the ESAF arrangement. Directors stressed that early implementation and careful monitoring of the program would be critical for the success of the Government’s development strategy.

Directors welcomed the actions taken by the authorities since the elections to bring the program back on track, the proposed cuts in military outlays, and the shift in government expenditure in favor of primary health care and education. The need for improving revenue collection and customs administration and tackling the problem of tax evasion to reduce the fiscal imbalance was emphasized by Directors.

With regard to structural reforms, Directors urged rapid privatization of most public enterprises and the two state-owned commercial banks. Because agriculture was critical for export growth and poverty alleviation. Directors stressed the importance of early attention to land tenure rights. A few Directors also stressed the urgency of implementing the proposed reforms in public administration, the importance of good governance, and the need to further enforce the rule of law.

Although exports were expanding, they were still insufficient to reduce the country’s dependence on foreign aid. Directors noted. Prospects for electricity and gas exports were good, but other exports needed to be increased. Directors recognized that Mozambique would require generous debt relief, given the external debt burden, including multilateral debt. Directors also noted the need for improving the administrative capacity to monitor closely foreign aid flows and uses, as well as counterpart fund generation.

Nigeria

Directors concluded the Article IV consultation with Nigeria in early November 1995 The discussion took place against a background of four consecutive years (1990–94) during which the rate of real GDP growth was in decline, inflation was accelerating, and the external position was weakening. Frequent swings in economic policy and expansionary financial policies had eroded confidence and discouraged long-term planning and investment, while inadequate infrastructure maintenance and poor performance by public utilities had raised production costs. During 1990–94, Nigeria’s trade surplus was more than halved, the current account balance shifted from a surplus of 10 percent of GDP to a deficit of 3 percent, and reserves fell to one month of imports. External payments arrears exceeded $9 billion at the end of 1994 (see Table 26).

Table 26NIGERIA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in November 1995; annual percent change unless otherwise noted)
199219931994119952
Domestic economy
Real GDP2.92.31.33.3
Consumer price index (end of period)48.861.376.835.0
External economy
Exports, f.o.b.1.5–8.2–15.610.0
Imports, f.o.b.10.7–7.0–17.98.1
Current account (in percent of adjusted GDP)–1.9–2.8–2.9–1.6
Direct investment (in billions of U.S. dollars)0.80.60.60.6
Capital account balance (in billions of U.S. dollars)–7.0–2.2–1.7–1.8
External debt (in percent of adjusted GDP)90.789.790.690.3
Debt service (in percent of exports of goods and services)69.943.347.746.1
Real effective exchange rate–17.29.083.2–27.5
Gross international reserves
(in billions of U.S. dollars)30.80.70.91.1
Financial variables
General government balance
(in percent of GDP)–7.9–18.1–8.8–1.4
Gross national saving
(in percent of GDP)22.613.715.218.7
Gross domestic investment
(in percent of GDP)24.516.717.719.7
Broad money51.348.038.418.1
Interest rate (discount rate)17.526.013.5

Estimated.

Projected.

Data on gross international reserves provided subsequent to the Board discussion by the Nigerian monetary authorities are as follows: 1992, $0.7 billion; 1993, $1.3 billion; 1994, $1.7 billion; and 1995, $1.4 billion.

Estimated.

Projected.

Data on gross international reserves provided subsequent to the Board discussion by the Nigerian monetary authorities are as follows: 1992, $0.7 billion; 1993, $1.3 billion; 1994, $1.7 billion; and 1995, $1.4 billion.

Preliminary information for the first half of 1995 indicated that a fiscal surplus had been realized in part as a result of constraints on spending, including a surplus in the newly formed Petroleum Trust Fund. By May, despite tightened monetary policies, inflation had risen 89 percent over the previous year. In addressing the distressed banking system, the authorities took vigorous action and appointed management teams in 17 insolvent banks. They were considering regaining control of the three largest banks, which had been privatized in 1993.

Although in their discussion Directors noted with concern the deterioration of Nigeria’s economic performance in 1994, they welcomed the tightening of fiscal policy and the establishment of an autonomous marker for foreign exchange in 1995. At the same time, Directors stressed that additional corrective measures would be essential and emphasized the inadequacy of a piecemeal approach to economic stabilization. Directors underscored the urgency of implementing a comprehensive set of macroeconomic policies in a medium-term framework, including a realistic unified exchange rate and wide-ranging structural policies that would open up the economy.

Directors regretted the continuation of controls on interest rates, which were negative in real terms and discouraged domestic saving and the efficient allocation of domestic resources. They therefore urged the authorities to liberalize interest rates and called for reform of the practice of the mandatory holding of government paper at negative real interest rates and the provision of cheap central bank, credit to the Government. Directors stressed the importance of prudent use of the resources in the Petroleum Trust Fund and the central bank’s profits to strengthen fiscal discipline. Directors were concerned about the proliferation of distress cases in the banking system, whose soundness could be restored only through corrective measures at the individual bank level and reinforcement of Supervision and control. They were disappointed at the authorities’ decision to maintain the official exchange-rate at a substantially overvalued level, which involved economic and administrative costs, and urged an early move to a unified market-based exchange rate system. While improvements in government accounting practices had been implemented, Directors were concerned about the lack of transparency and timeliness in the prior reporting of the Government’s accounts, and were of the view that further enhancements were needed.

Finally, Directors urged the authorities to work closely with Fund staff to formulate a comprehensive package of adjustment measures. They supported the idea of a good staff-monitored program, provided that there first be a significant improvement in policy implementation.

Pakistan

In December 1995, Directors met to conclude the Article IV consultation with Pakistan and to consider its request for a stand-by arrangement (see the section on Fund Support of Member Countries). A sharp drop in external reserves during July-November 1995 led Pakistan to embark on a comprehensive medium-term program of macroeconomic adjustment and structural reform. In 1994/95 policy implementation had been relaxed and poor weather and crop disease had affected growth and increased inflation.

Real GDP growth recovered to 5.5 percent in 1994/95, but this was lower than the target. Inflation, which peaked at 15.3 percent in the 12 months ended in January 1995, was 12.1 percent over the year. National saving in 1994/95, at 12.9 percent of GDP, was slightly lower than in 1993/94 (see Table 27).

Table 27PAKISTAN: SELECTED ECONOMIC INDICATORS

(Data as of Board discussion in December 1995; annual percent change unless otherwise noted)1

1992/931993/941994/951995/962
Domestic economy
Real GDP at factor cost2.34.54.46.0
Consumer price index
(end of period)9.111.912.19.0
External economy
Exports, f.o.b. (in millions of U.S. dollars)6,7826,6857,8848,988
Imports, f.o.b. (in millions of U.S. dollars)–10,049–8,685–10,137–10,926
Current account balance
(in millions of U.S. dollars)–3,326–1,650–2,091–2,665
Direct investment310360440949
Portfolio investment1372891,090116
Capital account balance
(in millions of U.S. dollars)2,7373,2342,3382,063
External debt (in percent of GDP)45.548.244.744.1
Debt-service ratio (in percent of GDP)322.522.722.524.2
Real effective exchange rate22.1–4.9–0.3
Net international reserves
(in millions of U.S. dollars)512–1,880–349515
Financial variables
General government balance–9.8–6.8–6.7–5.0
Gross national saving
(in percent of GDP)13.414.412.915.1
Total investment
(in percent of GDP)20.518.216.819.7
Money and quasi-money418.016.016.612.1
Nominal interest rate(s)12.312.411.712.0

Fiscal years (July 1 through June 30).

Fund staff estimates.

Excludes foreign currency deposit liabilities. Medium- and long-term debt service in percent of goods and services and net private transfers.

Changes in percent of the initial stock of domestic liquidity.

Fiscal years (July 1 through June 30).

Fund staff estimates.

Excludes foreign currency deposit liabilities. Medium- and long-term debt service in percent of goods and services and net private transfers.

Changes in percent of the initial stock of domestic liquidity.

Despite the macroeconomic imbalances, Pakistan had taken a number of steps to liberalize its exchange system since 1993–94. The rupee became fully convertible for current transactions; ceilings on foreign exchange purchases and other currency restrictions were abolished; and in July 1994 Pakistan accepted the obligations of Article VIII of the Fund’s Articles. To maintain an adequate level of competitiveness and provide stability for the economy, Pakistan had followed a managed floating exchange rate policy, based on small periodic adjustments of the rupee vis-à-vis the U.S. dollar.

Directors regretted that Pakistan’s adjustment and reform effort had faltered but were nonetheless encouraged by the reinvigoration of the authorities’ efforts in October 1995. They stressed that the new economic program should be rigorously implemented to achieve its objectives and rapidly re-establish confidence and urged the authorities to take additional corrective actions if necessary. It was noted that the large stock of short-term external debt and low international reserves allowed no scope for policy slippages.

Fiscal consolidation was a cornerstone of the adjustment program, Directors observed. They pointed out that a key element of the overall reform would be the removal of the regulatory import duty and a further reduction of tariff rates and urged the authorities to advance tariff reform. Structural reforms to improve the budget also needed vigorous implementation. Directors placed strong emphasis on extending the general sales tax, broadening agricultural taxation, and phasing out tax exemptions and concessions.

Directors underscored the need to control government expenditure and improve its efficiency and composition. They called for greater efforts to reduce unproductive spending, including military expenditures, and to increase developmental outlays. Directors emphasized that privatization proceeds should not be used to finance unsustainable increases in government expenditure and that it was critically important for Pakistan to improve the transparency of its budget management.

Key elements for bringing down monetary growth substantially in 1995/96 were strengthening of the fiscal accounts, reducing government-directed credit, and containing credit to public enterprises. To that end, Directors welcomed the removal of the credit-to-deposit ratio mechanism and the ceiling on rates of return.

Directors stressed that it was imperative that exchange rate policy be supported fully by restrained fiscal and monetary policies to contain inflation and preserve competitiveness. Most Directors felt that the flexible management of the exchange rate was appropriate.

Several Directors observed that, in today’s globalized financial system with swift financial market reactions, it was essential for Pakistan to establish a strong track record of fundamental and sustained adjustment. By doing so, it would restore and maintain the confidence of the markets and the international community.

Peru

In December 1995, Directors met to conclude Peru’s Article IV consultation and to discuss the midterm and financing-assurances reviews of the third year of the extended arrangement for Peru.

The Peruvian Government began implementing a macroeconomic and structural adjustment program in 1990 to reverse the hyperinflation, negative real growth, and external arrears that had developed over the previous decade. Under the program, economic activity rebounded strongly during 1993–94, and this improvement continued in 1995. Economic growth, while slowing to a more sustainable level than that registered in 1994, remained above 7 percent (see Table 28), while the 12-month rate of inflation fell to about 10 percent in October 1995. The current account deficit widened in the first half of 1995, reflecting higher imports associated mostly with private investment. However, net official international reserves continued to increase on the strength of capital inflows.

Table 28PERU: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in December 1995; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP–1.85.613.07.5
Unemployment rate9.410.18.8
Consumer price index73.248.523.711.0
External economy
Exports, f.o.b.4.2–0.529.620.4
Imports, c.i.f.15.9–0.138.634.2
Current account balance
(in percent of GDP)–4.8–5.2–5.4–7.4
Capital and financial account balance6.47.011.58.9
External debt3.74.27.27.1
Debt-service ratio (in percent of GDP)60.964.857.1
Real effective exchange rate2.8–7.56.5
Net international reserves (in millions of U.S. dollars)3082642,337906
Financial variables
General government balance (before privatization, in percent of GDP)0.30.60.70.5
Gross national saving (in percent of GDP)11.613.316.116.5
Gross domestic investment
(in percent of GDP)16.418.621.523.9
Broad money (end of year)84.175.246.829.9
Interest rate (lending, end of year)16.915.215.2

Projected.

Projected.

The nonfinancial public sector balance (excluding privatization receipts) was in surplus by 0.2 percent in January–June 1995, compared with a projected deficit of 0.4 percent. Lower noninterest spending and higher net operating revenues of public enterprises more than compensated for a shortfall in central government current revenues due to delays in implementing tax administration measures. Meanwhile, a more selective implementation of projects enabled the authorities to keep capital outlays below programmed levels.

During the first six months of 1995 the net domestic assets of the Central Reserve Bank contracted by about 24 percent with respect to currency in circulation at the beginning of the year, compared with 1 percent in the program. This development reflected the stronger fiscal position, larger commercial bank reserve requirement deposits, and larger placements of Central. Reserve Bank certificates of deposits. During April–August 1995 the Central Reserve Bank raised the rediscount rate by more than 5 points, increased the effective reserve requirements of banks by reducing their average period of computation, and tightened regulations to ensure full compliance with the reserve requirement. The 12-month growth rate of credit to the private sector, although decelerating from about 34 percent in December 1994 to 28½ percent in September 1995, remained higher than envisaged under the program. The new sol depreciated by 2.6 percent in real effective terms between December 1994 and August 1995, mainly because of the U.S. dollar’s depreciation against other major currencies.

Peru is currently providing adequately the core data to the Fund in terms of periodicity, timeliness, coverage, and quality. In their discussion, Directors commended the authorities for the impressive and successful implementation in recent years of sound macroeconomic policies and structural reforms, which had resulted in a significant reduction of inflation, the resumption of rapid economic growth, and the strengthening of the external position to a comfortable level. The widening of the current account deficit in 1995 resulting from the rapid growth of domestic demand raised important questions whether that development could be sustained. However, Directors noted that the widening of the external current account deficit reflected, in part, investments undertaken by the private sector that were essential to Peru’s economic development over the medium term.

Directors emphasized that a further strengthening of the fiscal stance was essential to ease demand pressures and reduce inflation while allowing room for private sector growth. They urged the authorities to persevere in their efforts to enhance revenue collection and welcomed their efforts to tighten spending. Directors also expressed admiration for the authorities’ interest in alleviating poverty and improving social conditions.

Because of the heavy burden placed on monetary policy by strong private capital inflows, the Board called for a continuing close review of the rapid growth of credit to the private sector. In that connection, the need to strengthen the supervision of financial institutions to promote effective financial intermediation was also emphasized.

Directors noted that the large private capital inflows were putting pressure on the currency to appreciate, hut they generally advised against introducing capital controls, which were not seen as a viable policy option. Directors emphasized the importance of a tight fiscal policy and the pursuit of a prudent wage policy to help preserve competitiveness.

Directors commended the far-reaching reforms introduced in labor market regulations, land rights, and the pension system. They encouraged the Government to persevere in its efforts to deepen the structural reforms and, in particular, to move forward decisively in privatizing state enterprises. In the context of Peru’s still difficult medium-term outlook. Directors welcomed the agreement reached in principle with commercial creditors on a debt package and encouraged the authorities to accelerate negotiations with non-Paris Club bilateral creditors.

Philippines

The Board met in September 1995 to conclude the Article IV consultation with the Philippines. It did so against a backdrop of a stronger-than-expected economic performance, but a policy performance that, despite substantial progress, still had fallen short of plans.

Economic activity had begun to accelerate in the second half of 1993, in response to policies enacted to promote export-oriented growth, overcome power shortages, liberalize the foreign exchange system, maintain fiscal restraint, and improve the country’s external position. To ensure a durable expansion, the Government in 1993 formulated a medium-term economic program that had at its core an overhaul of the tax system and restructuring of government expenditure and that formed the basis for the extended arrangement approved by the Fund in June 1994.

In 1994, the elements for a strong recovery were in place. GNP growth rose to 5.3 percent, remittances increased by 32 percent, the current account deficit narrowed to 4½ percent of GNP, increased foreign investment swung the overall balance into surplus, and inflation fell to 7.2 percent by year’s end (see Table 29). These favorable trends had continued through mid-1995: growth and inflation both remained steady, reserves rebounded sharply in response to a tightening of monetary policy in the second quarter, and exports surged.

Table 29PHILIPPINES: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in September 1995; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GNP1.62.15.35.7
Unemployment rate (in percent)9.89.39.59.5
Consumer price index8.97.69.08.1
External economy
Exports (in billions of U.S. dollars)9.811.413.517.4
Imports (in billions of U.S. dollars)14.517.621.326.4
Current account balance
(in percent of GNP)–1.6–5.5–4.5–2.5
Direct and portfolio investment
(net, in millions of U.S. dollars)7378121,5582,280
Capital and financial account balance
(net, in millions of U.S. dollars)1,6932,3064,4982,437
External debt (in billions of U.S. dollars)30.934.337.740.62
Debt- service ratio317.017.117.414.5
Real effective exchange rate (period average)12.0–2.36.65.9
Adjusted gross official reserves
(in billions of U.S. dollars)45.24.76.46.7
Financial variables (in percent of GNP unless otherwise noted)
Consolidated public sector balance–1.9–2.2–0.5–0.1
Gross national saving19.117.419.221.5
Gross national investment21.023.423.524.8
Broad money (end of period)27.831.734.738.3
Interest rate (annual average, in percent)516.112.313.611.3

Data revised subsequent to the Board discussion.

As of June 1995.

In percent of exports of goods and services; after rescheduling.

Gross reserves less securities and gold pledged as collateral for short-term loans.

Interest rate on 91-day treasury bills.

Data revised subsequent to the Board discussion.

As of June 1995.

In percent of exports of goods and services; after rescheduling.

Gross reserves less securities and gold pledged as collateral for short-term loans.

Interest rate on 91-day treasury bills.

The Government in July submitted to Congress legislation to redesign the tax system and reorganize the Government. In June, the Oil Price Stabilization Fund balance turned negative, but the Government initiated measures to increase oil prices and, more important, submitted legislation to establish an automatic oil price mechanism and to lift oil price controls.

In their discussion, Directors praised the authorities’ continuing efforts to open and liberalize the economy and to restore macroeconomic balance, which, along with greater political stability, had sparked the strong rebound in growth. Given the improvement in the Philippines’ external position, including the rapid growth in exports and the sharp decline in the debt service ratio, most Directors agreed with the authorities’ decision to consider the extended arrangement with the Fund as precautionary.

Considerable further efforts, however, would be needed to transform this recovery into a sustained economic expansion, in the Board’s view. Foremost among the policy requirements would be an increase in national saving, which would require prompt and decisive fiscal consolidation, and Directors urged the Government to move forward with planned reforms as quickly as possible. Tax reform would need to raise a significant and steady stream of revenues for the government budget, and it was important to proceed with rationalizing expenditures. Government reorganization should aim to achieve a substantial reduction in the civil service.

Apparent shifts in the demand for money and the presence of large capital inflows have complicated the task of monetary management. In response, Directors noted, the authorities have shifted toward a limited form of inflation targeting. Directors urged the authorities to err on the side of caution in conducting monetary policy, by maintaining base money below the program ceilings. They also noted that monetary conditions would need constant monitoring if the gains in reducing inflation were to be secured.

In this context, a variety of financial indicators should be monitored, and, when warranted, policy should be further tightened. In these circumstances, they observed, the authorities should not resist market pressures for an appreciation of the exchange rate.

Directors urged the Government to accelerate structural reforms and concurred with the authorities that the fundamental solution to problems in the oil sector would be prompt and full deregulation. In the interim, they urged the Government to adjust domestic oil prices and to eliminate the deficit in the Stabilization Fund speedily. Directors commended the Philippines’ acceptance of obligations under Article VIII of the Fund’s Articles. They welcomed the Government’s medium-term tariff reduction program and urged the lifting of remaining quantitative restrictions on agricultural products. Finally, Directors commended the Philippines for the timely and comprehensive statistics provided to the Fund.

Subsequent to the Board discussion, in early 1996, the Government implemented a major extension of the value-added tax and a substantial upward fuel price adjustment. In addition, it approved laws providing for deregulation of the oil sector and the removal of quantitative restrictions on agricultural products. Economic recovery also continued. GNP growth rose to 5.7 percent in 1995, propelled by manufacturing and exports. Inflation, however, increased to 11.5 percent in the first four months of 1996 mainly as high prices persisted pending full normalization of rice supply. The implementation of the expanded value-added tax and fuel price adjustment also exerted a short-term impact.

Senegal

Directors met in June 1995 to conclude Senegal’s Article IV consultation report and to conduct the midterm review of the country’s first annual arrangement under the ESAF. (The second annual arrangement under the ESAF was approved in December 1995; see the section on Fund Support of Member Countries.) The discussion took place against the background of the strengthened adjustment strategy adopted by the authorities in early 1994 to tackle the serious difficulties besetting the economy: deterioration in the terms of trade, slowdown in real GDP growth, widening of domestic and external imbalances, and accumulation of external payments arrears. The comprehensive adjustment program was predicated on the 50 percent devaluation of the CFA franc in January 1994 and comprised two main elements: the implementation of strong supporting fiscal and monetary policies, and the acceleration of structural reforms to improve incentives for the private sector and promote growth.

Overall results in 1994 were encouraging. Real GDP grew by 2 percent, close to the year’s program objective, and inflation—expected to be high after the price increases following the devaluation of the CFA franc—was kept below the projected rate of 39 percent (see Table 30). In the external sector, the fall in the real effective exchange rate—by some 35 percent after the devaluation—improved the economy’s competitiveness and shifted consumer demand toward domestically produced goods. However, disbursements of external budgetary assistance fell short of projections, owing mainly to delays in reaching agreement with the World Bank on the release of credits.

Table 30SENEGAL: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in June 1995; annual percent change unless otherwise noted)
199219931994119952
Domestic economy
Real GDP2.8–2.12.04.5
Consumer price index–0.1–0.632.17.8
External economy
Exports, f.o.b. (in millions of SDRs)587.9514.7554.3612.8
Imports, f.o.b. (in millions of SDRs)852.0789.0716.9774.5
Current account balance
(in percent of GDP)3–9.6–10.2–9.2–7.7
Overall balance (in millions of SDRs)–92.5–199.589.817.9
External debt (in percent of GDP)56.062.580.272.5
Debt-service ratio422.722.518.917.7
Real effective exchange rate–1.0–2.4–35.2
Gross official foreign reserves
(in weeks of imports)0.60.11.06.4
Financial variables
General government balance
(in percent of GDP)5–3.8–4.0–5.7–2.6
Gross national saving (in percent of GDP)4.43.04.47.9
Gross domestic investment
(in percent of GDP)14.013.213.615.6
Broad money (M2)3.6–12.639.219.6
Interest rate (discount, end of year)12.510.510.0

Estimated.

Projected.

Excluding official transfers.

In percent of exports of goods, services, and private transfers.

On commitment basis, excluding grants.

Estimated.

Projected.

Excluding official transfers.

In percent of exports of goods, services, and private transfers.

On commitment basis, excluding grants.

The authorities held the line on spending, particularly on wages. Government revenue performance was weaker than projected, however, primarily because of administrative weaknesses for which corrective actions were subsequently implemented. The overall fiscal deficit thus exceeded the program target by about 1 percentage point. Net bank credit to the Government and the net domestic assets of the banking system remained well under the applicable program ceilings; moreover, credit demand rose moderately in the second half of the year but was contained below the program’s limits.

Most of the structural reform measures planned for 1994 were implemented. Price controls on 12 commodities were eliminated as planned, and the marketing and processing of domestically produced rice was completely liberalized. However, the privatization of the groundnut marketing company was lagging behind schedule.

Directors remarked that, despite some setbacks, developments in Senegal had been generally encouraging in 1994. Economic growth had recovered, and the authorities had succeeded in containing inflationary pressures. There had also been sizable reflows of capital and a strong improvement in the net foreign assets of the banking system. Directors noted that most performance criteria and the quantitative and structural benchmarks under the ESAF arrangement had been observed, except for those related to the elimination and nonaccumulation of external payments arrears and government revenue.

In view of Senegal’s still fragile economic situation, Directors urged the Government to persevere with and intensify its adjustment and reform efforts. They emphasized that, to achieve the targeted fiscal deficit reduction in 1995, revenues would have to be increased by reinforcing the tax and customs administrations, widening the tax base, and reducing tax fraud. On the expenditure side, the authorities would need to contain the wage bill as programmed, limit public sector recruitment, hold down nonpriority outlays, and avoid extrabudgetary spending. The Board also underscored the importance of eliminating domestic and external payments arrears.

Directors urged the authorities to pursue a prudent credit policy and to strengthen monetary management by using indirect instruments more effectively. Efforts to accelerate economic integration and intensify the coordination of fiscal and monetary policies within the West African Economic and Monetary Union were also seen as essential.

Directors considered that the CFA franc devaluation had given the Government a window of opportunity to promote private sector development and diversify the economy. They called on the authorities to accelerate the implementation of the reforms already under way, in particular the privatization of the groundnut marketing company. The authorities were also encouraged to accept the obligations under Article VIII of the Fund’s Articles of Agreement at an early date.

Tunisia

Directors discussed the Article IV consultation with Tunisia in February 1996. Since 1986, Tunisia had made steady progress in implementing comprehensive structural reforms and had pursued consistently prudent macroeconomic policies. As a result, real GDP growth during 1986–93 averaged 3.8 percent a year, driven mostly by rising exports of manufactured goods and tourism. Structural reforms had included gradual reduction of non tariff trade barriers, liberalization of domestic prices and the incentive system, elimination of restrictions on current account transactions, and financial sector reform.

In 1994, real GDP growth stood at 3.4 percent and was estimated at 3.5 percent in 1995 (see Table 31), This was due to continued strong growth in manufacturing industries, mining, and services and offset declining oil production and a sharp contraction in the agricultural sector caused by drought. Inflation rose from 4.0 percent in 1993 to an estimated 6.2 percent in 1995, in part because of increased food prices.

Table 31TUNISIA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in February 1996; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP7.82.33.43.5
Consumer price index, average5.84.04.76.2
External economy
Exports, f.o.b. (in U.S. dollar terms)8.2–6.523.716.52
Imports, c.i.f. (in U.S. dollar terms)24.2–4.46.920.82
Current account balance, excluding grants (in percent of GDP)–7.0–7.1–2.9–4.5
Direct investment (in percent of GDP)3.14.32.41.5
Capital account balance
(in millions of SDRs)861794674679
External debt (in millions of SDRs, end of period)5,4445,6095,9226,318
Debt service ratio320.220.618.518.7
Real effective exchange rate42.1–1.20.52.1
Gross official reserves
(in months of imports)1.81.92.82.8
Financial variables
Central government balance, including foreign grants (in percent of GDP)–2.4–2.9–2.7–2.8
Gross national saving (in percent of GDP)22.221.321.421.1
Gross investment (in percent of GDP)29.128.823.825.0
Money and quasi-money7.27.07.87.6
Interest rate (in percent)511.38.88.88.8

Estimated.

Reflecting mainly the depreciation of the U.S. dollar against the currencies of Tunisia’s European trading partners.

As percent of exports of goods and services; including Fund charges.

Information Notice System.

Money market rate.

Estimated.

Reflecting mainly the depreciation of the U.S. dollar against the currencies of Tunisia’s European trading partners.

As percent of exports of goods and services; including Fund charges.

Information Notice System.

Money market rate.

The drought and lower-than-expected economic growth complicated fiscal consolidation. The overall fiscal deficit, excluding foreign grants, hovered around 3 percent of GDP in 1994 and 1995. In 1995, total revenue rose only by about 8 percent, well below the budget target of 15 percent.

External accounts improved sharply in 1994, with die current account deficit, excluding grants, narrowing to 2.9 percent of GDP. This reflected the strong growth of nonenergy exports, including large shipments of olive oil stocks, and a slowdown in import growth following the completion of two major energy projects. In 1995, the current account deficit was estimated to have widened to 4.5 percent of GDP, in part because of the drop in olive oil exports.

Directors commended the authorities for their steadfast pursuit of structural reforms and prudent macroeconomic policies. They welcomed the authorities’ commitment to build on the progress achieved and to pursue further structural reforms and macroeconomic consolidation in a medium-term context. Directors considered the medium-term strategy based on raising domestic saving and fostering a market-oriented, open, and private-sector driven economy appropriate to achieving higher and sustainable economic growth and lower unemployment.

Directors welcomed the conclusion of the Association Agreement with the European Union. This was seen as a critical framework for the expansion of trade and a clear signal of the authorities’ commitment to the further development and modernization of the Tunisian economy and its full integration into the global economy. Continued adjustment and reform were essential to reaping the full benefits of the Association Agreement.

To preserve macroeconomic stability and free resources for higher private investment, Directors emphasized the need for further fiscal consolidation. In particular, they noted that achieving the fiscal target for 1996 would require forceful implementation of the envisaged revenue and expenditure measures. The authorities’ intention to develop and strengthen the value-added tax system with a view to offsetting the revenue losses resulting from trade liberalization was welcomed. Directors also encouraged increased efforts to contain the growth of the wage bill in the context of the ongoing civil service reform and to reduce consumer subsidies. Directors observed that a strengthening of public finance would facilitate the continued implementation of a prudent monetary policy.

Directors broadly supported the Central Bank’s policy of keeping the real effective exchange rate stable in the context of restrained financial and incomes policies. They, nonetheless, stressed that the exchange rate policy should continue to be kept under close review.

The importance of strengthening the incentive system in parallel with industrial restructuring to promote higher saving and investment and attract large flows of foreign direct investment was underscored. Directors encouraged completing the liberalization of domestic prices, introducing greater flexibity in the labor market, strengthening human capital development, and moving further with trade liberalization. They welcomed the accelerated pace of privatization and urged its widening to all sectors and to large public enterprises.

Directors encouraged the acceleration of financial sector liberalization and urged that remaining controls on interest rates be phased out and savings institutions reformed to help increase saving and the efficiency of financial intermediation.

Economies in Transition

In the Fund’s classification of countries, transition economies cover three groups: central and eastern Europe and the Baltic countries; Russia and the other countries of the former Soviet Union; and Mongolia. Although each of these displays unique traits, a characteristic common to all of them is the transitional state of their economies from a centrally administered system to one based on market principles.

Among the central and eastern European countries and the Baltic countries, the Board concluded Article IV consultations with Albania, Bulgaria, Croatia, the Czech Republic, Estonia, Latvia, Lithuania, the former Yugoslav Republic of Macedonia, Poland, Romania, the Slovak Republic, and Slovenia. In general, economic performance in these countries continued to improve; attempts to keep inflation under control were mainly successful; and further advances were made in the liberalization of trade and payments systems. Some worrying fiscal developments had emerged in many countries, however, and progress in implementing structural reforms—especially in the financial sector—was uneven.

All of these countries were pursuing serious stabilization and reform efforts. Those countries that had adopted strong programs at an early stage and were more advanced in the transition—such as Albania, the Czech Republic, Poland, the Slovak Republic, and Slovenia—were reaping the benefits in the form of rapid growth. Directors observed, however, that signs of possible overheating had emerged in the Czech Republic, and that in Poland reducing inflation had proved more difficult than anticipated.

Although most countries had succeeded in keeping inflation in check, price stability would continue to pose a major challenge. For those countries where there was a potential for overheating, Directors stressed the need to strengthen policies to achieve an early slowing of inflation and wage increases. In this context, Directors noted with concern the relaxation of fiscal policy in many countries and underscored the need for continued vigilant and prudential fiscal management.

Progress in achieving structural reform was mixed. In particular, fragile banking systems and financial indiscipline had been a major source of macroeconomic instability in some countries. In latvia and Lithuania, the slow pace of banking reforms and the failure to react quickly to signs of trouble had resulted in full-scale banking crises. Enterprise restructuring and privatization efforts had also bogged down in many countries—even in some of the more advanced economies, such as the Slovak Republic and Slovenia. In other countries, such as the former Yugoslav Republic of Macedonia and Romania, stabilization remained fragile because of slow progress in implementing structural reforms.

Directors expressed broad support for the flexible exchange rate policies adopted by most of these countries—which gave appropriate scope to the play of market forces. Many urged other countries, such as the Czech Republic and Poland, to introduce more flexibility into their exchange rate regimes. Some other Directors counseled the authorities to guard against significant erosion of competitive positions in the wake of strong inflows of capital and their potential impact on the exchange rate. Several Directors called into question the efficiency of capital controls, however. In general, Directors urged the authorities to monitor the external situation carefully and to stand ready to adjust the policy stance as needed.

Virtually all countries in this group had taken further steps to liberalize their trade and payments systems, and several were moving toward—or had achieved—full current account convertibility. A worrisome exception was Romania: Directors noted renewed problems in the exchange market, and they underscored the importance of sustained and consistent application of the policy understandings that had been reached regarding exchange rate management as a basis for continuing Fund support.

In the case of the other transition economies, Arti cle IV consultations were concluded in 1995/96 with Armenia, Azerbaijan, Belarus, Georgia, Kazakstan, Moldova, Mongolia, Russia, and Ukraine. Directors welcomed the determined efforts in most of these countries directed at stabilization and market-oriented reforms, although they regretted that Ukraine’s effort had faltered in the second half of 1995 after a promising start. Many countries still had to contend with external and domestic instabilities, however, and slow-progress in structural reform continued to keep even the more successful of them from realizing their full economic potential.

The fiscal situation in most of these countries remained fragile. Directors noted that permanent reductions in unproductive spending, together with measures to improve revenue performance, were needed. Directors cautioned, however, against deep, unsustainable expenditure cuts, emphasizing, rather, the importance of revenue-enhancing measures. In this context, they suggested that stronger efforts were required to improve tax collection and administration. Containing inflation continued to pose a major challenge, and for some countries—notably Russia—further reduction in inflation remained the policy priority. Nevertheless, Directors noted that in some countries, such as Belarus and Kazakstan, tight monetary and fiscal policies had succeeded in reducing inflation.

Directors stressed that successful macroeconomic stabilization needed to be supported by strong and stepped-up progress in structural reform and noted with concern that the pace of such reform had been disappointing. Financial systems remained fragile, and Directors urged country authorities to take strong steps to reform the sector through improving banking supervision, enhancing banks’ operational capabilities, and strengthening the regulatory framework for non-bank financial institutions. The pace of enterprise restructuring, privatization, and reform of the legal system also needed to be accelerated to ensure an effective transition from state-run to market-oriented economies.

Directors generally welcomed the pursuit of a flexible exchange rate policy by countries in the region. In the case of Russia, some Directors questioned the feasibility of simultaneously maintaining an exchange rate band and sticking to the revised money growth path needed for visible disinflation. For Russia, and for other countries as well, Directors emphasized the importance, in the light of changing circumstances, of keeping exchange rate policy under review.

Noting the fragility of the external position of many countries, which in some cases was compounded by a heavy external debt burden, Directors urged country authorities to restructure their external debt and to normalize relations with creditors. The prospects for some other countries, such as Azerbaijan, however, were more favorable, although Directors cautioned that the prospect of large revenues from oil exports should not weaken the resolve to maintain disciplined policies.

Georgia

In September 1995 the Executive Board met to conclude the 1995 Article IV consultation with Georgia and to conduct the first review of the program under a stand-by arrangement approved in June 1995. (In February 1996, the stand-by arrangement was replaced by Georgia’s first annual arrangement under the ESAF; see the section on Fund Support of Member Countries.)

The Georgian economy began to show signs of stabilization in 1995, with remarkable progress in halting hyperinflation (see Table 32) and stabilizing the coupon exchange rate. The exchange rate first appreciated from an unofficial rate of 5 million coupons per U.S. dollar at the beginning of the stabilization effort in September 1994 to 1.3 million coupons by late 1994, but since then had been stable against the U.S. dollar and had appreciated against the Russian ruble. The rate of decline in output slowed, with encouraging signs of increased activity in agriculture, transportation, and retail trade.

Table 32GEORGIA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in September 1995; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP–44.8–25.4–11.4–5.02
Employment–21.2–9.7–0.1
Consumer/retail prices
(period average)38873,12518,9221602
External economy
Exports, f.o.b. (in millions of U.S. dollars)267457381181
Imports, c.i.f. (in millions of U.S. dollars)645905744399
Current account balance (in millions of U.S. dollars)–318–485–446–191
Capital account balance (in millions of U.S. dollars)248306–19.3–56.1
Gross external debt (percent of GDP)8.251.780.242.6
Debt-service ratio (percent of exports of goods and nonfactor services)0.72.931.151.2
Exchange rate (coupons/U.S. dollar, period average)41,102,300
Net international reserves (in billions of coupons, end of period)–152–37.43,308–22,358
Financial variables
General government balance (in percent of GDP; accrual basis)–37.3–26.2–16.5–5.92
Broad money (end of period; including foreign currency deposits)623,09373,26755,699
Interest rate (commercial bank deposit rate for coupons)12.5–153–5

January–June unless otherwise indicated.

Projection for entire year.

Before 1993, according to the retail price index; after December 1993 according to a 295-good Laspeyres index.

According to the Tbilisi Interbank Currency Exchange.

January–June unless otherwise indicated.

Projection for entire year.

Before 1993, according to the retail price index; after December 1993 according to a 295-good Laspeyres index.

According to the Tbilisi Interbank Currency Exchange.

A sharp reduction in the overall fiscal deficit from 16.5 percent of GDP in 1994 to 6.9 percent in the first half of 1995) played a central role in the stabilization effort. Revenue performance remained weak, mostly because of inadequate tax administration. Expenditure was reduced from over 24 percent of GDP in 1994 to about 13 percent in the first half of 1995, but there was little flexibility for further cuts.

Monetary expansion slowed considerably: reserve money grew by 25 percent in the first half of 1995, compared with about 400 percent in 1994. There was virtually no National Bank lending to commercial banks in the first half of 1995, and foreign exchange operations were used to partially sterilize net credit to the Government. The rise in reserve money resulted from a greater demand for newly introduced domestic currency than had been anticipated and was accompanied by stronger-than-programmed performance in net international reserves.

Structural reforms included the reorganization of the State Tax Service, the implementation of a treasury project, and an assessment of government domestic expenditure arrears. A notable action was the removal of 132, 000 health sector personnel from the budgetary payroll as part of a move to a fee - for-service health care system. Draft land reform and antimonopoly laws were submitted to the Parliament. However, there were also slippages in structural reform, the most important being the accumulation of new budgetary obligations for gas imports.

Progress on statistical issues was mixed. A new consumer price index was developed, and improvements in government finance and monetary statistics were implemented, but little headway was made on national income and balance of payments statistics.

Directors commended the authorities on their determined efforts at stabilization and market-oriented reforms in extremely difficult circumstances. They were encouraged by the initial signs that output in some sectors had begun to recover and by the success in halting hyperinflation, creating a positive environment for the introduction of the new currency, the lari.

Directors noted that public finances remained weak, and that success in stabilization was therefore highly fragile. Revenue performance, although improved, continued to be disappointing. Directors urged the authorities to intensify their efforts to further strengthen fiscal institutions, improve tax and customs administration, reduce widespread tax exemptions, and further improve mechanisms for monetizing food grants. They also noted the importance of vigilance in expenditure control.

Directors observed that the acceptance of the new currency by the population would depend on the diligent implementation of supporting financial policies. They therefore urged the authorities to resist any pressures on the National Bank of Georgia to loosen its credit policies. Careful monitoring of the monetary aggregates would be essential.

The weak state of the banking system was of serious concern to Directors, who urged the authorities to speedily design and implement a program that could address the deep-seated structural weaknesses in the banking system.

Board members noted Georgia’s extremely difficult medium-term balance of payments outlook, dominated by its heavy external debt burden and urged the authorities to intensify their efforts to restructure their external debt and normalize relations with creditors.

Notwithstanding strong performance to date, Directors noted the unfinished agenda of structural reforms. They were disappointed about delays in the passage of commercial banking, land, and antimonopoly laws, but welcomed the progress that had been made in privatization during the previous year. They encouraged the authorities to act soon on the restructuring of government, a further downsizing of budgetary institutions, and improved targeting of social expenditures.

Mongolia

Directors met in February 1996 to conclude the Article IV consultation with Mongolia and to review its second annual arrangement under the ESAF. The discussion took place against the backdrop of the country’s substantial progress toward a market economy.

Since it began the transition process in 1990, Mongolia had gained considerable ground, notably through comprehensive liberalization of prices, trade, and the exchange system. As a result, cumulative output loss had been held at about 20 percent during 1990–93, and in 1994 positive real growth resumed.

Transition efforts continued in 1995, supported by the second annual ESAF arrangement. The Government had taken measures in mid-1995 to renew financial restraint, and all end-1995 fiscal and monetary benchmarks under the ESAF program were met. Real GDP increased by 6 percent (see Table 33), and private sector activity continued to expand in livestock, mining, construction, and trading. The current account deficit (excluding official transfers) was held to 7 percent of GDP. Copper and noncopper exports increased, more than offsetting the effect of buoyant imports owing to the higher growth rate. Net official international reserves rose but were still equivalent to only six weeks of imports. External commercial borrowing was avoided, and outstanding external debt declined in relation to GDP. Inflation, however, was higher than planned, at 53 percent for the year.

Table 33MONGOLIA: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in February 1996; annual percent change unless otherwise noted)
19941995119962
Domestic economy
Real GDP2.36.35.0
Employment3–12.70.93.0
Consumer prices (end of period)66.353.125–30
External economy
Exports, f.o.b. (in millions of U.S. dollars)367.0451.0436.5
Imports, c.i.f. (in millions of U.S. dollars)370.5473.0500.8
Current account balance (excluding official transfers; in percent of GDP)–5.8–7.1–9.6
Direct investment (in millions of U.S. dollars)7.010.014.0
Capital account balance (in millions of U.S. dollars)–36.25.837.1
External debt (in percent of GDP)468.656.656.4
Debt service (in percent of current receipts)516.314.112.1
Exchange rate (Tug/US$, end of period)414474539
Net official international reserves
(in millions of U.S. dollars)37.250.060.0
Financial variables
Overall budget balance (in percent of GDP)–24.6–11.1–10.9
Gross national saving (in percent of GDP)15.116.614.8
Gross capital formation (in percent of GDP)20.923.724.4
Broad money81.427.230.0
Interest rates672–26472–150

Preliminary.

Revised program targets.

Based on a sample of the largest enterprises.

Excluding debt of 10 billion transferable rubles to Russia and other former members of the Council for Mutual Economic Assistance (CMEA).

Excluding servicing of medium- and long-term obligations in transferable rubles to Russia and other former members of the CMEA.

Cental bank clearing rate, in percent a year.

Preliminary.

Revised program targets.

Based on a sample of the largest enterprises.

Excluding debt of 10 billion transferable rubles to Russia and other former members of the Council for Mutual Economic Assistance (CMEA).

Excluding servicing of medium- and long-term obligations in transferable rubles to Russia and other former members of the CMEA.

Cental bank clearing rate, in percent a year.

In their discussion, Directors commended Mongolia for the progress made since 1990 in promoting macroeconomic stability and structural change. Although they expressed disappointment at the weakening of financial restraint in the first half of 1995, they welcomed the Government’s corrective measures at midyear and its renewed commitment to continue reform. As a result, most program objectives had been met. Directors were particularly satisfied that real GDP growth had risen markedly for the year, and they believed that prospects were good for continued strong output growth in 1996.

Directors were concerned, however, that the inflation rate remained excessively high and that Mongolia’s external position was still fragile, as evidenced by the low level of reserves. They stressed the importance of implementing policies for more ambitious reduction of inflation and for strengthening the external position. Directors supported the 1996 budget, with its provisions for a higher current surplus in relation to GDP and for avoiding domestic bank financing of the overall deficit. They urged the Government to ensure that key revenue measures were fully in place at an early date, including eliminating income tax and customs duty exemptions, extending the sales tax, and strengthening tax administration. Firm control over current expenditure would be critical, Directors stressed; limiting the wage bill to less than the inflation rate and finalizing plans to reduce civil service employment were priorities. However, they said that adequate provision of education and health, in support of the country’s urgent needs for human resource development, should be made during public sector downsizing.

Directors endorsed the 1996 financial program, which provided for increased credit to facilitate private sector activity while keeping strict limits on loans to public enterprises. In their view, monthly credit ceilings should be retained until banks had established a record of sound [ending policies, and the gradual development of indirect instruments of monetary control should continue. Directors saw a need to strengthen the central bank so that it could effectively conduct anti-inflationary policies, and this would entail comprehensive modern banking legislation. They urged the authorities to accelerate rehabilitation of the banking system, including the strengthening of banking supervision and prudential regulation.

Directors stated that public enterprise reform was crucial to achieving budgetary, credit, and inflation objectives. In particular, energy price increases should be implemented at an early stage to cover operating costs, help meet investment needs, reduce the need for bank borrowing, and generate revenue. Similarly, the cash privatization program should be expanded to include large, profitable public enterprises, and actions taken to speed the rationalization or closure of unviable enterprises.

With regard to Mongolia’s external position, in the Board’s view the Government would need to improve absorptive capacity for official aid, avoid external commercial borrowing, and maintain competitiveness. Mongolia, Directors emphasized, was at a critical juncture in its economic transformation. It would be essential to implement policies resolutely under the ESAF arrangement and—in order to enhance credibility—to avoid further policy slippages. Mongolia’s acceptance of the obligations under Article VIII of the Fund’s Articles was welcomed.

Poland

Directors concluded the 1995 Article IV consultation with Poland in January 1996, reviewing the economic developments over the previous year. Poland continued to perform at the cutting edge of the economies in transition, and yet this strong progress had not been without its risks.

The country had enjoyed impressive GDP growth of over 6.5 per cent during the year under review (see Table 34), reflecting growth of 9.4 percent in industrial production and a 13 percent increase in agricultural output. However, the expansion in activity was unbalanced, since it was driven mainly by exports and investment, while domestic demand remained subdued. Toward the end of the year, however, there had been signs of a pickup in real wages and consumer confidence.

Table 34POLAND: SELECTED ECONOMIC INDICATORS(Data as of Board discussion in January 1996; annual percent change unless otherwise noted)
19921993199419951
Domestic economy
Real GDP2.63.86.06.5
Unemployment rate (end of period)13.616.416.0
Consumer price index (period average)43.035.332.228.4
External economy
Exports, f.o.b. (in millions of U.S. dollars)13,99713,58516,95022,971
Imports, c.i.f. (in millions of U.S. dollars)13,48515,87817,78624,395
Current account balance (in millions of U.S. dollars)21,575–852,1283,463
Direct investment (in millions of U.S. dollars)284580542900
Capital account balance (in millions of U.S. dollars)–1,472–679–3304,788
External debt (end of period; in billions of U.S. dollars)48.248.740.939.4
External debt-service ratio320.021.516.215.3
Commercial exchange rate depreciation
(-) against U.S. dollar (period average)–22.4–24.9–20.3
Net international reserves (increase; in millions of U.S. dollars)1,6146342,5349,200
Financial variables
General government balance
(in percent of GDP)–6.6–2.9–2.0–2.8
Gross national saving4 (in percent of nominal GDP)17.015.517.818.6
Gross domestic investment (in percent of nominal GDP)15.215.615.515.7
Broad money (money and quasi-money)557.536.038.334.0
Warsaw interbank offered rate
(end of year, in percent)44.334.128.425.5

Fund staff estimates.

Including unrecorded trade.

In percent of exports of goods and nonfactor services in convertible currencies.

July 1995.

Percent change in stocks at end of year.

Fund staff estimates.

Including unrecorded trade.

In percent of exports of goods and nonfactor services in convertible currencies.

July 1995.

Percent change in stocks at end of year.

Net international reserves had increased beyond expectations, over whelming the National Bank of Poland’s sterilization capacity and boosting broad money growth, which complicated attempts to bring down inflation. However, falling food prices, a hardening of the exchange rate policy, and some tightening of the fiscal policy led to a decline in inflation in the second half of 1995.

The authorities’ main response to the surge in net international reserves was exchange rate action. The focus was initially on slowing down the rate of crawl, but in May 1995 an element of flexibility was introduced In the form of a craw ling band of ±7 percent around the central parity. The zloty quickly appreciated to 5 percent (later 6 percent) above the central rate. Moreover, in December 1995 the authorities raised the central parity by 6 percent and allowed the actual rate to appreciate by 2½ percentage points.

The fiscal outcome in 1995 was better than expected, with the general government deficit provisionally estimated at 2¾ percent of GDP, but was still worse than in 1994. However, this good bud get a 17 outturn was in part the result of high wage growth during 1995 (5 percent in real terms), which boosted income tax receipts and social security contributions. Privatization and corporate income tax revenues were also higher than expected, while expenditures were held slightly below projected levels.

The transformation to private ownership accelerated toward the end of the year, and a revised draft of the privatization law was being prepared. Also, a blueprint for the medium-term pension reform was approved by the Council of Ministers in December.

In their discussion, Directors commended Poland’s impressive economic performance, including the very rapid industrial growth and the boom in exports, noting that the country’s success was the result of several years of steadfast stabilization and reform efforts. They observed, however, that reducing inflation had proved more difficult than anticipated, and they emphasized the importance of forward-looking, reform-oriented policies for continued success.

Directors believed that further reduction of inflation should be the top priority for macroeconomic policy, and, to that effect, the framework for the conduct of monetary and exchange rate policies needed to be clarified. While the crawling-peg regime had served Poland well in the past, Directors generally considered that a more flexible exchange rate policy could increase the effectiveness of monetary policy and bring about lower inflation. These policies should be supported by a tighter fiscal stance and resolute progress with structural reforms.

Directors commended the authorities for keeping the general government deficit to below the target of 3 percent of GDP but emphasized the importance of making further progress, primarily through fiscal consolidation. Directors underscored the importance for continued rapid growth and fiscal viability of further structural reforms. They welcomed the progress made in mass privatization and trade and exchange reform, including the acceptance of the obligations under the Fund’s Article VIII. But progress in other areas had not been so extensive, and they urged that the authorities encourage broad reform of social security, strengthening of the revised privatization law then under preparation, and a timely completion of the restructuring and privatization of the commercial banks. Also, wage indexation should be reduced.

Romania

In December 1995 the Board met to discuss developments in the Romanian economy in 1994 and 1995 in the context of the 1995 Article IV consultation. They also conducted a review of, and considered a request for the extension and augmentation of, the stand-by arrangement with the Fund approved in May 1994 (see the section on Fund Support of Member Countries).

Economic performance during 1994 was marked by a sharp improvement in confidence, reflecting forceful implementation by the authorities of restrictive fiscal and monetary policies. Real money demand increased after four years of decline. The exchange rate stabilized at a market-clearing level by mid-1994, after which substantial purchases were made to rebuild official reserves. Consumer price inflation plunged to one third of its 1993 rate. Exports grew by 24 percent, and real consumption increased substantially, with economic growth accelerating to 4 percent in 1994 (see Table 35).

Table 35ROMANIA: SELECTED ECONOMIC INDICATORS(Data, except for 1995 outturn, as of Board discussion in December 1995; annual percent change unless otherwise noted)
1995
1992199319941ProjectionOutturn
Domestic economy
Real GDP–8.81.33.95.06.9
Unemployment rate17025.97.8–10.0–10.1
Consumer/retail prices (average)2102561373132
External economy
Exports, f.o.b.
(in billions of U.S. dollars)4.34.96.17.47.5
Imports, c.i.f.
(in billions of U.S. dollars)5.46.06.68.98.8
Current account balance
(in billions of U.S. dollars)2–1.5–1.2–0.5–1.5–1.3
Direct investment
(in billions of U.S. dollars)0.30.40.4
Capital account balance
(in billions of U.S. dollars)1.41.31.21.21.3
Gross external debt
(in billions of U.S. dollars)33.44.45.55.946.2
Debt-service ratio
(in percent of current receipts)8.15.88.913.012.1
Lei/U.S. dollar (end of period)4601,2761,7672,54252,578
Net international reserves
(in billions of let, end of period)6803682,3892,192 53,426
Financial variables
General government balance
(in percent of GDP)–4.6–0.1–1.0–2.8–2.5
Gross domestic saving
(in percent of GDP)22.923.824.924.925.5
Gross fixed domestic investment
(in percent of GDP)18.817.920.021.020.8
Broad money (end of period)80141138527667
Interest rate (weighted National
Bank of Romania average, in percent)444167856 567

Fund staff estimates.

Excludes trade in transferable rubles.

Convertible currencies, including letters of credit and payments due for imports received.

September 1995.

October 1995.

Foreign currency and gold converted into lei at end-of-period exchange rates; gold and SDRs valued at constant dollar prices.

The figure for 1995 excludes interest payments by the Savings Bank.

Fund staff estimates.

Excludes trade in transferable rubles.

Convertible currencies, including letters of credit and payments due for imports received.

September 1995.

October 1995.

Foreign currency and gold converted into lei at end-of-period exchange rates; gold and SDRs valued at constant dollar prices.

The figure for 1995 excludes interest payments by the Savings Bank.

Economic developments in the first nine months of 1995 were more problematic. Already in the second half of 1994, slippages in structural policies were evident. The quasi-fiscal deficit in the enterprise sector was not addressed forcefully enough, resulting in strong credit pressures by early 1995 and a rundown in reserves. Intervention by the authorities in the exchange rate worsened the situation. Thus, although growth accelerated to 7 percent in 1995, balance of payments pressures re-emerged. Exports increased by 23 percent, but imports rose by twice that much, sharply widening the current account deficit.

Unemployment began to decline in 1995, and consumer prices continued to slow dramatically. Money demand increased, but more slowly than in 1994. Real wages accelerated sharply, boosting consumption and allowing real household saving to increase at the same time. By contrast, the financial position of the enterprise sector deteriorated significantly from early 1995, in part because of heavy stockpiling of imported raw materials such as oil and increased inventories in sectors dominated by large state-owned enterprises. Plans to slim down state-owned enterprises with large losses or arrears were delayed. And the National Bank’s room for maneuver in tightening liquidity was limited by a large program of subsidized agricultural financing, launched by the Government in late 1994.

Directors noted that the Romanian economy had expanded strongly in 1994 and 1995, accompanied by sharply decelerating inflation and a reduction in unemployment. A continuation of this progress required an acceleration of structural reforms and steadfast stabilization. Directors expressed strong concerns that structural policies had begun to slip subsequent to the May 1994 approval of the stand-by arrangement. There had been renewed intervention in the exchange market, and pressures for credit to agriculture directed by the National Bank had been accommodated. These were seen as worrisome reversions to non-market-oriented policies and had contributed to a rapid expansion of credit and an unsustainable widening of the balance of payments deficit during 1995.

Directors welcomed the measures taken since September 1995 to improve resource allocation in the economy and to reduce the current account deficit. The fiscal tightening begun in late 1995 and planned for 1996 was urgently needed, given the serious balance of payments pressures.

Directors urged the authorities to avoid further interference with the functioning of the exchange market; this was essential to preserving confidence in domestic financial assets and preventing a further depletion of external reserves. Directors supported flexible management of the exchange rate, accompanied by tight financial and incomes policies to reduce inflation.

Directors agreed that the core source of instability in the economy was the quasi-fiscal deficit of the state enterprise sector. While some encouraging steps had been taken lately by the authorities, structural reform remained sluggish. It was most important that forceful action be taken to reform problem enterprises in state-owned industry and agriculture. While the legal framework for privatization was largely in place, successful implementation was necessary for an increase in private sector activity, which in turn was required if sustainable growth and a continuing rise in living standards were to be achieved.

Directors encouraged the authorities to improve the quality of data on the monetary and national accounts, as well as those on the operations of the major state-owned enterprises that had large losses or arrears. In light of Romania’s fragile external position, it was imperative for the authorities to avoid further policy slippages or reversals and to fulfill all of their policy commitments; otherwise they risked undermining confidence in the economy, jeopardizing the economic recovery and posing a risk to the country’s external position.

Russia

In September 1995, the Board discussed economic developments in Russia during the second half of 1994 and the first half of 1995 in the context of the 1995 Article IV consultation. At the same time, they conducted the first quarterly review of Russia’s program under the stand-by arrangement approved in April 1995.

The key concern for the period under consideration was inflation, which after reaching a low of 4.6 percent on a monthly basis in August 1994 accelerated to 17.8 percent in January 1995. While it then fell significantly, to 5.4 percent by July 1995, it remained considerably above the objective for July of 1 percent. The slower-than-envisaged reduction in inflation was partly the result of base money growing faster than expected, owing to the effects of substantial inflows of foreign exchange.

On the external front, the current and capital accounts strengthened significantly during the first half of 1995. Mainly because of a rise in exports to countries outside the former Soviet Union, total exports rose by 18 percent over the first half of 1994 (see Table 36) and the consolidated current account registered a surplus of S3 billion, compared with a deficit of $0.4 billion in the first half of 1994. At the same time, a strengthening of the capital account reflected a sharp decline in private capital outflow.

Table 36RUSSIA: SELECTED ECONOMIC INDICATORS(Data, except for full year 1995, as of Board discussion in September 1995; percent change over same period in previous year unless otherwise noted)
1995
199219931994Jan.–Jun.Full year
Domestic economy
Real GDP1–19–12–15–4–4
Registered unemployment20.81.12.12.73.2
Open unemployment24.85.57.17.78.3
Consumer price index, average1,353896302186190
External economy
Exports, f.o.b. (in billions of U.S. dollars)352.158.369.636.978.6
Imports, c.i.f. (in billions of U.S. dollars)346.544.255.228.960.6
Current account balance
(in billions of U.S. dollars)3–4.22.63.42.94.7
Capital account balance
(in billions of U.S. dollars)3–12.3–19.3–2.30.2
External debt120.6115.9
Debt-service ratio424.920.3
Average exchange rate
(rubles/U.S. dollar)2221,0342,2624,5944,560
Net international reserves553830013840
Financial variables
Federal government balance
(in percent of GDP)6–11.1–6.9–11.1–3.4–4.6
Enlarged government balance
(in percent of GDP)7–18.97.6–10.1–2.9–4.9
Gross national saving28.927.0
Gross national investment27.725.9
Base money51,07064718671118
Net domestic assets of the monetary authorities3,85313471851578
Refinance rate of central bank
(end of period, percent)80210180180160

Goskomstat has recently revised its GDP statistics for 1992 and 1994. The figures shown here are based on the official (unrevised) data.

End-period level, in percent of the labor force.

Consolidated for transactions both with states of the former Soviet Union and with other countries.

Public external debt service due, in percent of total exports and nonfactor services.

Changes in relation to base money at beginning of the period.

On a cash basis.

Includes the federal and local governments, all extrabudgetary funds, and unbudgeted import subsidies associated with foreign disbursements.

The monetary authorities are defined to include the Central Bank of Russia and the Government.

Goskomstat has recently revised its GDP statistics for 1992 and 1994. The figures shown here are based on the official (unrevised) data.

End-period level, in percent of the labor force.

Consolidated for transactions both with states of the former Soviet Union and with other countries.

Public external debt service due, in percent of total exports and nonfactor services.

Changes in relation to base money at beginning of the period.

On a cash basis.

Includes the federal and local governments, all extrabudgetary funds, and unbudgeted import subsidies associated with foreign disbursements.

The monetary authorities are defined to include the Central Bank of Russia and the Government.

The authorities introduced an exchange rate band regime in July 1995, committing themselves to the management of the exchange value of the ruble.

In the fiscal area, the federal government deficit was reduced through expenditure compression in excess of the shortfall in all major revenue categories. The poor revenue performance was caused by a number of factors, including delays in implementing revenue-enhancing measures and in eliminating exemptions, a rise in tax arrears, continued difficulties in tax compliance (including from the emerging private sector), and the impact of the nominal appreciation of the ruble. The authorities also successfully introduced a treasury bill market, which provided a critical source of nonin-flationary finance.

Structural reforms during the year under review included further trade liberalization (notably in the export sector) and liberalization of the oil export regime, but the rate and scale of privatization and land reform were slower than expected. Major social programs, including that for unemployment benefits, were both inadequate and financially inviable.

Notwithstanding these difficulties, Directors noted, the Russian authorities had met all the targets under the program to date, and they commended the authorities on their strenuous efforts to persevere in stabilization process. Their progress had been impressive when viewed against the conditions at the beginning of 1995, There were signs that the real economy had finally begun to recover from the collapse it had been enduring since 1991, and inflationary pressures had eased considerably.

Directors particularly commended the resolve with which the authorities had pursued the goal of fiscal deficit reduction. Expenditure had been severely compressed. However, Directors expressed concern over the sustainability and possible economic costs of that compression. Noting that the fiscal situation remained fragile, they stressed that permanent reductions in unproductive spending, together with measures to improve revenue performance, were urgently needed. They welcomed the revenue package introduced by the authorities, but they considered that more needed to be done to ensure the viability of fiscal policy over the medium term.

Directors emphasized that the further reduction of inflation must remain the policy priority. The growth of the monetary base needed to be firmly restrained. The authorities would have to pay particularly close attention to the operation of the exchange rate band. Directors emphasized the need to keep exchange rate policy under continuous review, and for the authorities to remain prepared to make adjustments if necessary.

Directors expressed concern over difficulties in the banking system and encouraged the authorities to take strong steps to improve banking supervision and accelerate reforms that would lead to the restructuring of the banking sector. In a number of other structural areas, notably land reform and privatization, Directors urged the authorities to accelerate the pace of reform.

During the latter half of 1995, following the Board discussion, the Russian authorities continued to comply with all the program’s monetary and fiscal targets, although with increasing difficulty toward the end of the year. As a result of Russia’s performance under the program, for the year as a whole inflation fell to an average rate of 190 percent, compared with 302 percent in 1994. The year 1995 also saw the first signs of a recovery of industrial activity, particularly in such areas as energy, metallurgy, and chemicals. Real GDP remained broadly stable in the course of 1995, at an average level some 4 percent below that recorded in 1994. On the external front, the current account surplus widened to 4.7 percent of GDP from 3.4 percent in 1994. The introduction of the exchange rate corridor with the stated purpose, among others, of stabilizing exchange rate perceptions, is generally judged to have been a success. On the structural front, policy performance continued to be uneven. The restructuring of the banking sector, for example, was slow, and the pace and scale of the privatization program was below expectations. Little progress was achieved in the area of land reform. In March 1996 the Fund approved an arrangement under the extended fund facility totaling SDR 6.9 billion (see the section on Fund Support of Member Countries).

Slovak Republic

The Board met in September 1995 to discuss under Article IV the economic performance of the Slovak Republic over the past year. The economy had turned around dramatically during 1994, with 5 percent growth, a 6 percent surplus on the current account, a doubling of official foreign reserves, and a halving of inflation to 12 percent (see Table 37). These developments resulted from the combination of a 20 percent surge in exports (spurred on by productivity growth and progress in restructuring) and low domestic demand resulting from sizable fiscal adjustment and tight credit. Growth was sustained in the first half of 1995, with preliminary data pointing to a stronger-than-expectcd recovery of domestic demand led by investment and nongovernment consumption.

Table 37SLOVAK REPUBLIC: SELECTED ECONOMIC INDICATORS(Data, except for 1995 outturn, as of Board discussion in September 1995; annual percent change unless otherwise noted)
1995
1992199319941Jan.–JuneOutturn
Domestic economy
Real GDP–7.0–4.14.86.17.5
Unemployment rate (in percent of labor force, period average)11.312.814.614.313.8
Consumer price index
(CPI; 12-month change)9.125.011.710.57.2
External economy
Exports, f.o.b. (in billions of U.S. dollars)6.55.46.74.28.6
Imports, c.i.f. (in billions of U.S. dollars)7.26.426.64.28.5
Current account balance0.03–0.60.70.30.6
Foreign direct investment, net
(in billions of U.S. dollars)0.1–0.40.30.10.2
Other medium- and long-term capital (in billions of U.S. dollars)0.30.60.70.10.7
Overall balance (in billions of U.S. dollars)–0.50.41.40.61.6
External debt (in billions of U.S. dollars, end of period)42.83.43.94.5
Debt-service ratio
(in percent of total exports)3.38.98.712.0
Real effective exchange rate
(CPI-based; average)1.10.8–0.31.51.9
Official reserves (end of period;
in billions of U.S. dollars)0.80.92.23.13.9
Financial variables
General government balance
(in percent of GDP)–12.8–7.6 2–1.42.00.6
Gross national saving
(in percent of GDP)23.2318.0522.821.56
Gross domestic investment
(in percent of GDP)22.8 321.9517.119.5 6
Broad money (end of period)4.718.518.42.920.8
Interest rate (credit to private sector; average)16.114.114.914.614.5

Preliminary.

Military imports of $170 million in 1993 (in exchange for a write-down of Slovak claims on Russia) are captured in the external accounts (imports) but not in the fiscal accounts.

After fiscal transfers from the Czech lands, estimated at about 7 percent of GDP.

Excluding disputed interbank liabilities to the Czech Republic.

Military imports from Russia are excluded from foreign saving and the general government deficit.

Projection for the whole year.

Preliminary.

Military imports of $170 million in 1993 (in exchange for a write-down of Slovak claims on Russia) are captured in the external accounts (imports) but not in the fiscal accounts.

After fiscal transfers from the Czech lands, estimated at about 7 percent of GDP.

Excluding disputed interbank liabilities to the Czech Republic.

Military imports from Russia are excluded from foreign saving and the general government deficit.

Projection for the whole year.

The fiscal deficit was reduced by 6 percentage points to 1½ percent of GDP in 1994, much below the program target (under a stand-by arrangement approved in July 1994) of 4 percent. Nominal expenditures were slightly higher than projected, but the cut in the deficit was made possible by higher revenues from direct taxes owing to stronger-than-expected economic activity. This good performance continued into the first half of 1995, when general government operations showed a sizable surplus, as spending was held below budgeted amounts by controlling discretionary expenditures.

Broad money rose faster than targeted during 1994, but this was consistent with increased demand for financial assets and stemmed entirely from a rise in net foreign assets of the banking system. From mid-1994 the National Bank of Slovakia sterilized large foreign exchange inflows associated with the surge in export receipts. Continued sterilization and a fiscal surplus kept growth in broad money to 3 percent during the first half of 1995.

The Slovak Republic had benefited from structural reforms introduced in earlier years, and tight financial policies that imposed hard budget constraints on enterprises. However, political instability and administrative constraints had delayed implementation of structural reform in recent years. The Slovak Republic had met the performance criteria for its precautionary program at the end of 1994, but progress was hampered by slow formulation of structural policies and an unexpected shift in privatization policy. In June 1995 the Government decided to cancel the second-wave voucher scheme; to distribute privatization bonds (valued at the equivalent of 8 percent of GDF) to the population; and to maintain state ownership or control in a large number of enterprises.

Directors commended the Slovak authorities for achieving an impressive economic turnaround based on tight financial policies and earlier structural reforms. They noted, however, that the recent slippages in structural policies had delayed the completion of the first review under the stand-by arrangement and hoped that the authorities would regain the momentum of reform, thus improving the prospects for a sustained recovery in growth and investment.

Directors were concerned that setbacks in privatization had damaged the credibility of the Government’s commitment to a market economy and reduced the attractiveness of the Slovak Republic to foreign investors. They urged the authorities to reinvigorate the privatization process, stressing the need to harden budget constraints and eliminate state interference in privatized enterprises.

Directors emphasized that tighter financial policies were needed to prevent the economy from overheating. In light of the risks stemming from rapidly rising domestic demand and from the inflationary effects of the privatization bonds, they recommended the adoption of a more ambitious fiscal target for 1995, based on spending cuts. They also noted that the cost of future structural reforms would put additional pressure on the fiscal accounts in the coming years.

Directors noted that the National Bank’s prudent policy stance had been key to the gains in stabilization, and they welcomed the authorities’ recent decision to tighten credit policy and to adopt additional measures if necessary. They encouraged the authorities to complete the transition to market-based instruments as soon as feasible, and to strengthen the independence and effectiveness of the National Bank. Directors welcomed the recent steps to strengthen the financial position of the commercial banks.

Directors commended the Slovak authorities for their intention to liberalize the exchange system further, with the aim of full current account convertibility and accepting Article VIII status by January 1, 1996. They regretted the authorities’ decision to maintain the import surcharge until mid-1996 and urged its early removal.

Ukraine

Directors met in January 1996 to conclude the 1995 Article IV consultation with Ukraine. Since the last consultation, the authorities’ commitment to policy reform had varied, with three main phases. In late 1994 and the first half of 1995, the authorities pursued strong policies to lower inflation and reform the economy. In April 1995 they adopted a budget that reduced the role of the state in the economy and reformed the system of taxation. They obtained a rescheduling of their outstanding debt and payments arrears and pledged to service their rescheduled obligations on time. They also took steps to speed up mass privatization and open up the foreign trade regime.

During the following months, the pace of reform slowed. In July, the Government renewed various forms of financial support to the enterprise sector, including through direct budgetary lending. External payments arrears were incurred, both on payments for gas imports and on foreign debt-service obligations, and structural reforms lagged behind schedule.

In the closing months of 1995, in view of the negative impact of these slippages, in particular on inflation, the authorities tightened monetary policy somewhat. This helped to reduce inflationary pressures and stabilize the exchange rate. Other corrective actions to bring the program back on track, however, were postponed.

Economic activity remained weak during most of 1995, but the estimated decline in GDP of 13 percent for the year was a significant improvement over 1994 (see Table 38). Lower-than-expected agricultural output contributed to the decline in real GDP.

Table 38UKRAINE: SELECTED ECONOMIC INDICATORS(Data us of Board discussion in January 1996, percent change over same period in previous year unless otherwise noted)
19921993199419951
Domestic economy
Real GDP–17–17–23–13
Employment–2.0–2.3–3.8
Consumer price index1,2104,735891376
External economy
Exports, f.o.b. (in billions of U.S. dollars)11.312.811.812.3
Imports, c.i.f. (in billions of U.S. dollars)11.915.314.214.4
Current account balance (in millions of U.S. dollars)–621–854–1,395–1,380
Direct investment (in millions of U.S. dollars)17020091120
Capital account balance (in millions of U.S. dollars)–2,087–317–238–2,206
External debt service (in millions of U.S. dollars)161971,7871,531
Debt-service ratio0.11.212.410.2
Exchange rate (Krb/US$ auction rate; end of period)74925,000104,200183,000
Net international reserves (in millions of U.S. dollars; end of period)284–486
Financial variables
General government balance
(in percent of GDP)–29.3–11.8–8.2–4.1
Gross national investment
(real percentage change)–36.9–10.3–22.7
Broad money (M3)29212,103465105
Statutory refinance rate
(in percent a year; end of period)252105

Fund staff estimates.

Foreign currency deposits valued at parallel exchange rates through September 1994. For purposes of comparison, foreign currency components of actual observations for 1995 are valued at the program exchange rate, which is an accounting exchange rate.

Fund staff estimates.

Foreign currency deposits valued at parallel exchange rates through September 1994. For purposes of comparison, foreign currency components of actual observations for 1995 are valued at the program exchange rate, which is an accounting exchange rate.

Exports performed strongly in 1995, especially those to countries outside the former Soviet Union, which were estimated to have increased by about 40 percent in U.S. dollar terms over the first three quarters of the year, more than offsetting the fall in trade with countries in the former Soviet Union. 1 his good performance reflected earlier trade liberalization measures. Imports remained essentially flat, as a contraction in energy imports offset an increase in other imports. The exchange rate was relatively stable during much of the first half of 1995, when capital inflows helped to strengthen the balance of payments. But as policy implementation weakened during the summer, the karbovanets depreciated, stabilizing again in October-November when the National Bank took steps to tighten monetary policies to restore confidence. The real exchange rate appreciated by about 60 percent over 1995, but the economy’s external competitiveness continued to be supported by a low level of dollar wages compared with the country’s main competitors.

Consumer price inflation slowed significantly during the first half of 1995, but it picked up in September and October because of the loosening of monetary policy, administered price adjustments, and seasonal factors. When the National Bank tightened its credit policy in October, this helped to correct the inflationary trend, and the monthly inflation rate fell to 4.6 percent in December.

Directors regretted that Ukraine’s reform effort had faltered in the second half of 1995, after a promising start under the adjustment program supported by the fund. Although impressive achievements had been realized initially, including lower inflation, a reduced budget deficit, and a liberalized exchange and trade system, slippages in important policy areas in the second half of 1995 had damaged the credibility of the authorities’ policies. In particular, Directors noted with concern the continued accumulation of external arrears on debt-servicing and current payments obligations, weakening fiscal performance, slow progress in areas of systemic reform, and limited progress on privatization and private sector development.

Directors were encouraged by the implementation of corrective actions in some areas, including the tightening of monetary policy late in the year. They urged the authorities to take further actions to revive the adjustment and reform program and pave the way for a resumption of financial support from the Fund and the international community. The highest priority was correcting Ukraine’s macroeconomic imbalances, which required sustained fiscal adjustment. The authorities’ budgetary targets for 1996 were not attainable on the basis of the current policies. They emphasized the need for a prudent wage policy, a better targeting of social benefits, and a move to a commercial system of interenterprise dealings in external energy trade.

Directors agreed that a flexible exchange rate regime should be maintained, supported by financial restraint to contain inflation and preserve competitiveness. They were concerned by the large increase in base money during December 1995 and urged the authorities to reinforce their efforts to reduce monetary and credit growth through a strengthening of fiscal adjustment and enterprise reform.

Directors underscored the need to speed up structural reforms, including faster privatization of state enterprises, enterprise restructuring, and financial sector reform.

Directors encouraged the authorities to remove all remaining export restrictions. They noted the need for a comprehensive energy policy. They welcomed the authorities’ intention to restructure the energy sector and encouraged the enforcement of payments discipline, thus ensuring steady gas supplies from abroad without reliance on government guarantees. They strongly urged the authorities to remain current on foreign debt obligations.

Directors recommended that the authorities improve their coordination of economic policy and encouraged them to cooperate more closely with the Fund staff in designing and implementing economic policies. Sustained and coherent implementation of strict financial policies and structural reforms would be essential to move the Ukrainian economy along the path of financial stability, market transformation, and sustained growth, and to re-establish credibility with donors, creditors, and investors.

    Other Resources Citing This Publication